Are American Stocks Overvalued?

Worries that U.S. stocks are grossly overvalued have been increasing in recent months and it is easy to see why.

The value of the S&P 500 has increased by 71.71% in the past five years; 27.11% in the previous three years and 15.73% over the past year. That growth has shown no sign of ending; the value of the Standard & Poor’s 500 grew by 6.68% between January 1 and May 3, 2017.

This growth has many analysts worried because the rate of growth for stock values is nearly seven times that of the U.S. gross domestic product (GDP). The GDP growth rate for the first quarter of 2017 was .7% according to Trading Economics. The average growth rate for American GDP over the past 70 years was 3.21%.

Is There a U.S. Stock Market Bubble

The serious disconnect between GDP and the S&P 500; which is supposed to reflect the value of the 500 most valuable publicly-traded U.S. corporations, is fueling fears of a stock market bubble. Some experts are even talking about the potential for a stock-market crash.

There were only two periods in history when American stocks were as overvalued as they are now, Yale Economics Professor Robert Shiller told CNBC. The first was in 1929; on the eve of the Great Depression, the other was in 2000 right before the burst of the dot.com bubble.

Shiller based his conclusion on the cynically adjusted price earning or CAPE ratio – which he helped create. Despite that, Shiller is not convinced a crash is imminent, he noted that the U.S. stock market was greatly over valued for two years before the dot.com bubble.

Instead even higher prices might be possible because of the unusual nature of today’s economic situation. Shiller admitted that there’s a strong possibility the market might keep going up for the foreseeable future.

Why are U.S. Stock Prices so high?

This brings us to the obvious question: why are US stock values so high when economic growth is anemic? Some possible explanations include:

Low Interest Rates and Returns on Savings

The return on some securities is terrible because of low interest rates which lead to low returns on bonds and savings. A Series EE U.S. Savings Bond was paying an interest rate of .1% between May 1a and October 31, 2017. The Daily Treasury Yield Curve rate for one month averaged between .67% and .73% on May 3, 2017. The return on the average savings account in the United States was .18% on April 12, 2017, while the rate for a one year Certificate of Deposit (CD) a popular savings instrument in America rose to .53% on the same day.

Investors that want a higher return have little choice but to turn to the stock market. This trend is further distorted by the U.S. law, which makes many retirement funds that invest in the stock market tax deferred.

The U.S. Real Estate Market

Many Americans were badly burned by the great real estate crash of 2007 to 2008. Those who lived through it distrust real estate and might prefer investing in more liquid instruments such as stocks.

Also driving the trend is the high price of real estate in the United States. This discourages property investment and encourages property owners to sell and reinvest the money in stocks.

Some of the Americans most skeptical of real estate are in the executive suites. Instead of expanding companies like Walmart, McDonalds and General Electric have been buying stock back. The companies are buying stock because returns on it are higher than on real estate or expansion.

A few observers expect that the trend will accelerate if President Trump’s proposal to lower the corporate tax rate finds favor in Congress. Trump wants a 15% corporate income tax; the current rate is 35% which encourages U.S. companies to hold cash overseas. Some of that money would presumably be spent on stock buybacks.

Foreign Money

Money from other parts of the world has been flowing into American stocks because foreign investors view them as more stable and paying a higher return.

This pessimistic view is justified by the performance of some foreign markets. The Shanghai Composite’s value dropped by 2,031 points between June 12, 2015 and May 3, 2017; for example. Investors are being scared out of other parts of the world by political upheavals such as the French election and Brexit.

Pension and Retirement Funds

Huge amounts of money are being poured into stocks as the world’s population ages.

Most of this investment takes the form of index and mutual funds, which enjoy substantial tax benefits in many countries including the United States. Investment in some retirement investments such as Australian superannuation or super accounts is encouraged by law.

The sums involved can be vast, the largest U.S. index fund operator; Vanguard, now controls $4.2 trillion worth of investment capital, The New York Times reported. That number has quadrupled in just seven years, as recently as 2010; Vanguard only controlled $1 trillion in funds.

Nor was it just in the United States, Australians had invested $2.2 trillion in super funds as of December 30, 2016, The Association of Superannuation Funds of Australia estimated. That made Australia the fourth largest holder of pension assets in the world.

The reason for the explosion in such savings is obvious; there are tens of millions of people nearing retirement age in some industrialized countries. There are an estimated 74.9 million Baby Boomers;” persons born between 1945 and 1965, in the United States alone. Australia has 5.5 million Baby Boomers out of a population of 24.6 million.

Therefore American stocks might not be overvalued at all. The high stock values in the United States might be the result of simple demographics.

That raises the possibility that the growth in U.S. stocks might continue for the next few years. Another result of this scenario would be a substantial drop in U.S. stock prices at some point in the 2020s, as pensioners begin cashing out their retirement funds. All this means it might be several years before we see any sort of meaningful stock market correction in the United States.

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