Stock market valuations are severely stretched by historical standards. Earnings multiples and other financial ratios no longer make sense. But despite this, investors are still buying.
I continue to preach: the days left in the stock market’s rise are numbered.
As I see it, excessive speculation rules the stock market right now. And that is dangerous because investors are making decisions that they shouldn’t be making. Irrationality is growing. Those who say the stock market will decline, like me, are few and far between.
Investors are putting big money into companies that are nowhere near being profitable.
Just look at Amazon.com, Inc. (NASDAQ/AMZN), a component of the S&P 500. According to bigcharts.com, Amazon.com stock is selling at 573 times its earnings! Since the stock market rally that began in 2009, the stock price of this online retailer has climbed more than 800%.
The price-to-book ratio of Amazon.com (that is the ratio of market value of the company compared to its book value) stands at 17.38. (Source: Yahoo! Finance, last accessed March 24, 2014.) The price-to-book ratio for Amazon.com’s sector—online retailers—is 11.0. (Source: New York University Stern School of Business web site, last accessed March 24, 2014.) By this measure, Amazon.com is overvalued by almost 60% compared to its sector average.
But Amazon.com is just one example of an overpriced stock; there are many other companies in the S&P 500 that don’t make sense as an investment, unless you are playing the “greater fool” theory. That’s when you buy a stock not because it pays a good dividend or because it makes a lot of money, but because the next guy will pay more for the stock than you did.
But something is happening with the stock market.
When I look at the price action, I see investors are finally getting tired and exhausted. They are not able to drive prices higher like they used to. Please look at the following chart of the S&P 500:
On the chart, I have indentified three areas where we see the stock market moving sideways (red circles) before the S&P 500 hits a new high. You will quickly notice the new highs are not as robust as they used to be. And they don’t stretch very far anymore before the market subsequently weakens.
And as the stock market makes new highs, we see volume declining (black lines at the bottom of the chart). This tells me investors are not as excited about the market making new highs as they used to be; instead, they see each subsequent high as a time to sell, not to buy more.
Finally, in addition to all this, I see the number of stock market bears continuing to dwindle. I am one of the few who have been saying the stock market will decline; the majority of advisors have become bulls.
Investors need to be very careful when this kind of stock market behavior prevails. From my experience, in the long-term, markets tend to do the opposite of what everyone expects and the bigger the expectations, the bigger the disappointment. Once stock market participants realize they are wrong, they will switch sides very quickly and sell, as euphoria doesn’t last forever. Once reality hits, it won’t be a pretty sight for the stock market.