A Safety-First Strategy


James Stack Image James Stack President, Stack Financial Management

Any investment strategy today must allow for the fact that we’re in the 8th year of the second longest bull market in Wall Street history, cautions Jim Stack, money manager and editor of InvesTech Market Analyst.

In addition, and this economic recovery — now at 7-years-old — is also very mature at almost twice the average duration of economic recoveries over the past century.

One very persistent storm cloud that continues to hold our attention is that US stocks — in general — are not cheap. We looked at almost 90 years of S&P 500 valuation data, based on the P/E ratio using trailing 4-quarter earnings.

Currently trading at a P/E of 24.3, the S&P 500 Index is about 30% overvalued compared to its long-term average of 17.1, and has been residing in this elevated valuation range since last year’s market peak in May.

Overvaluation alone does not cause a bear market, but it is a barometer of risk and reflects the absence of a “margin of safety.” This is especially important if making new stock purchases today.

Whether or not this bull market has seen its high, current valuations are significantly greater than at levels of past market peaks. The S&P 500 holds a higher valuation today than at all but one of the previous market tops.

Furthermore, as the Tech Bubble of the late ’90s proved, overpriced markets can continue to move higher, but this only increases the risk when the bull market starts to unravel.
Historically, data confirms that higher P/E ratios almost always lead to deeper bear markets.

The economically-sensitive Dow Jones Transportation Average and the Russell 2000 Small Cap Index are struggling to recover along with the blue chip averages.