Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



The 1 Bubble Warning Worth Listening To (It Isn't One!)

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Following an eight-week winning streak, stocks kicked off December with a down day as the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) fell 0.3% and 0.5%, respectively.

This month, my colleague Morgan Housel explained "How the Media Blows Bubbles." It's an important question, as stocks have continued to move higher with impressive regularity, the B-word has been popping up with increasing frequency in the financial media.

While most would-be seers in the media and finance aren't worth spending a minute of your time on, Robert Shiller of Yale is worth listening to. Shiller is one of the recipients of this year's Nobel Prize in Economics for his work on the predictability of long-term stock returns; better yet, he's tested his work "by fire," making some prescient calls, including the dot-com bubble and the real estate bubble.

Over the weekend, the German weekly Der Spiegel published excerpts of an interview with Professor Shiller, including the following quote [my emphasis]:

I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets. That could end badly. I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable.

All well and good, but how does Shiller himself invest in that environment? He's invested in stocks -- "those he still believes are undervalued." Within that group, he counts stocks from the energy and health-care sectors. As far as the finance and technology sectors are concerned, he's out of those entirely.

Here's a way to think about the market's performance and its valuation: By my reckoning, 50 stocks in the S&P 500 -- one in 10 -- account for roughly half of the year-to-date rise in the index (remember, the S&P 500 is market capitalization-weighted). The median forward price-to-earnings multiple for those 50 stocks is 16.8. The average forward P/E, weighted by market value, is 18.5; once you remove (NASDAQ: AMZN  ) (P/E 176!) from the group, that average falls to 15.7.

(Even for Amazon, I think there is an argument to be made that, given the size of the opportunities the company is pursuing and management's long-term focus, the shares aren't overvalued. Still, I wouldn't expect huge returns from current levels.)

Those are hardly the sort of numbers that would suggest a market in the throes of generalized euphoria. Facebook (NASDAQ: FB  ) offering $3 billion in cash to acquire photo-messaging application Snapchat? That is irrational exuberance, yes -- the sort that can quickly torch shareholder value. (Facebook investors ought to be very grateful that Snapchat's management was even more deluded and turned the offer down!) Twitter gaining 73% on its first day of trading? Same thing. However, those are examples of a "local phenomenon," that concerns social-networking equities, not a broad speculative bubble.

Let me state things categorically: We're not in a stock market bubble. However, it's quite possible that stocks are 10% to 20% overvalued. That needn't exclude long-term investors from investing in shares, but stock pickers ought to make the most of their privilege to focus on issues that still offer value and avoid those that are manifestly overpriced.

The 1 stock to own for 2014
The market stormed out to huge gains across 2013, leaving investors on the sidelines burned. However, opportunistic investors can still find huge winners. The Motley Fool's chief investment officer has just hand-picked one such opportunity in our new report: "The Motley Fool's Top Stock for 2014." To find out which stock it is and read our in-depth report, simply click here. It's free!

Read/Post Comments (0) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2749537, ~/Articles/ArticleHandler.aspx, 9/30/2016 4:41:02 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 18,308.15 164.70 0.91%
S&P 500 2,168.27 17.14 0.80%
NASD 5,312.00 42.85 0.81%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/30/2016 4:20 PM
^DJI $18308.15 Up +164.70 +0.91%
AMZN $837.31 Up +8.28 +1.00% CAPS Rating: ****
FB $128.27 Up +0.18 +0.14%
Facebook CAPS Rating: ***