One of the more difficult issues facing today's investor is the apparent overvaluation of the U.S. stock market. Several years ago, Benjamin Graham suggested that, as the price of a security increases, the prospect of a future profit decreases.
If we apply his logic to today's U.S. stock market, one would conclude that future stock returns may be well below average. Despite the demonstrated resiliency of the present bull market, there will most certainly be a correction at some point. Moreover, the longer this bull persists, the severity of a decline rises as well. In this blog, we'll take a closer look at this issue.
Market Valuation
As of Friday, Dec. 8, 2017, the current bull market was 3,196 days old (total days). This ranks as the second-longest bull on record. How overvalued is the domestic stock market?
Fortunately, we have several methods to help answer the question.
Perhaps the most widely accepted compares total U.S. stock market capitalization to GDP. The premise behind this option is that rising stock prices need the support of economic growth. This option was also dubbed "Warren Buffet's favorite" market valuation tool in a Fortune magazine interview from December 2001. Using this option, U.S. stocks are currently 40.3% overvalued. Since January 1971, stocks have only been more overvalued on 26 days, or 0.27% of the total period. It's worth noting that the peak was when the dot-com bubble burst in March of 2000.
