The market has been growing for years now, and by a lot of estimates, it's a bit overvalued today.
In this clip from Industry Focus: Tech, Motley Fool analysts Dylan Lewis and David Kretzmann discuss a listener question on whether or not it's wise for investors to wait for a correction before buying in. Find out how overvalued the market is today, how often markets correct historically, a few reasons some analysts are still counting on a bull market to continue well into the future, and more.
A full transcript follows the video.
This video was recorded on April 21, 2017.
Dylan Lewis: "The stock market seems to be highly overvalued. From what I last read, the long-term average of the P/E ratio of the S&P 500 has been about 15, and now it's over 26. Would now still be a good time to invest during this bull market, or would it be better to sit on some cash and wait for a while and hopefully see that market correction and invest then?" I love this question, and, broadly, I love getting listener questions. If someone out there is thinking something, chances are there are dozens or hundreds of Fools all thinking the same thing. Hunter, thanks for writing in. If other people have questions, firstname.lastname@example.org. Let's jump right into it, David. He's talking about market timing. I think this is something that's on a lot of people's minds. If you consume financial news at some point over the last year, you've probably seen something along the lines of, "The market is due for a huge correction," right?
David Kretzmann: You're probably been hearing that since 2009, since the Great Recession. It is a common fear, especially when you've had a multiyear bull market, and you have stocks hitting fresh highs on what seems like a pretty regular basis. We haven't had many 10% sell-offs over the past seven years. It's a good question, and it's something to keep in mind as an investor. On average, the stock market declines about 10% every 11 months, or about every year. Then, you'll have a bigger 20%, 30% or more decline every three to five-plus years. As an investor, you want to expect the market to go down. That's just part of the price you pay as an investor to get historically above-average returns with the stock market. But, I'll take a contrarian point here, since we will be talking about some of the potentially bearish indicators. Going forward right now, the market looks historically a little pricey when you look at the P/E ratio of 26. As you mentioned, the historic ratio tends to fall a little closer to 15 or 16 or 17. The forward P/E ratio of the S&P 500 right now is 18. That means, based on what analysts are expecting, the S&P 500 is expected to earn over the next year, right now the market is priced at 18 times those forward earnings. That shows that expectations are pretty high that growth will continue for the companies in the index. That's one angle. On a forward basis, if these companies can continue to grow, maybe they can grow into the valuation, and you don't necessarily need a big sell-off to revert back to those historical averages. That's one angle.
A couple other things we're actually going to talk about on Motley Fool Money today as well, on our radio show, the housing market is still below its historical averages. The housing market has slowly but surely been recovering since the Great Recession. But housing starts, which basically means the construction of new homes, is still below the long-term averages going back to 1960. As millennials now, people between the age of 18 and 34 in the U.S., they're now the largest demographic in the U.S. ahead of baby boomers. As people our age, Dylan, start to get closer to 30, they're thinking, "Maybe I don't want to rent a house anymore, I want to buy a house or even build a house," that does a lot to spur growth within the economy, because there's so much that goes into the purchase and the upgrade on the renovation of a house. That's something that can drive economic growth and spending over the long term. Just a couple things there. Yes, on the surface level, the market does look pricier than normal. But there are some factors that make me think, it doesn't necessarily mean you're going to have a huge crash right away. That's not to say that's not going to happen. As I mentioned before, you want to be prepared as an investor for some sort of sell-off down the road.
Lewis: I think, to add to that, you look back over the last year and a half or so, and the market has navigated what I would say are two major shocks to the system, one of them being Brexit, and the other one being the election of Donald Trump. Two big surprises that the market really wasn't anticipating. And yet, it has weathered it and continued to grow at this really great rate.