Optimism in the Face of an “Overvalued Market”

Optimism in the Face of an “Overvalued Market”

Back in April 2016, the market became the 2nd longest bull market in history. The market continues to march upward … em … flatling on this bull streak. The longest bull market was from 1987-2000. For this to beat it, it would have to keep going until the year 2021 (Source: http://money.cnn.com/2016/04/29/investing/stocks-2nd-longest-bull-market-ever/).

The question I have is, “How do you know when to pull out of an overvalued market?” Before you burn too many calories trying to answer it, I should warn you that it’s a trick question.
I began my career in financial advising at the end of this 1987-2000 bull market. When the market finally went down, everyone was quoting Alan Greenspan’s famous warning that the markets were “irrationally exuberant”. Overvalued markets are always obvious in hindsight and this became the catch phrase to poke fun of the Dot Com over valuation mania.

The key detail with this is that Greenspan coined this phrase on December 5, 1996 – a little over three years before the market peaked. Let’s use the S&P 500 as our market proxy and assume we are reinvesting dividends. If you had invested a $1.00 on the date of his warning, the value would have continued to rise to $2.54 on March 17, 2000. Your value would then drop precipitously until it bottomed out on October 9, 2002. This is what your journey would have looked like:

This is a hypothetical example for illustrative purposes only.

Maybe not a pleasant experience, but by ignoring him, you would have still been positive by 40% even after the sharp decline after the market peaked in March of 2000. If we were to go back to October of 2002 there were plenty of people out there barking about continued over valuation. If you had chosen at that moment to ignore them, this would have been your experience up to the end of last year:

This is a hypothetical example for illustrative purposes only.

Even with the all the setbacks along the way, you would still be up by about five times what you started with. Your main chore along the way was to simply ignore everything and everybody.
As we stand here on the shoulders of the 2nd longest bull market in history, I can’t help but wonder whether this is 1996 or whether it is 2000. My philosophy is always that it doesn’t matter, at least eventually and that the best rule of thumb is to ignore everybody and assume the pessimists are wrong.

I don’t know whether the market is overvalued and neither does anybody else for that matter, but the persistent lesson of history is that optimism always wins in the long run.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.