The Folly of Mean-Reversion

Yes, the market is overvalued.

And yes, we’ll continue buying stocks.

You see, these are the two seemingly-contradictory statements I resolve in my head daily.

Robert Shiller’s cyclically adjusted P/E ratio that Harry talks about above is one voice in the overvalued argument. And today’s chart, which Doug Short of Advisor Perspectives constructed, is another.

Using four different measures of valuation, Doug quantifies the market’s overvaluation, putting it in the range of 42% to 70%. Here are his valuation metrics, for the S&P Composite Index, going back to 1900.

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Such insights are very valuable to any investor, but it’s my job to find opportunities you can take advantage of… not to time the market. That’s why I don’t let empirical evidence of a market’s overvaluation alone move me to the sidelines.

For one, we’ve long known that trends in asset prices can persist much longer than expected, so trading with the trend rather than attempting to predict its end is the more profitable way to play the markets.

For another, historical instances of extreme valuations never occur in a vacuum. As Doug Short puts it: “At today’s low, annualized inflation rate and the extremely poor return on fixed income investments… the appeal of equities, despite overvaluation risk, is not surprising.”

That’s why, despite Harry’s macro outlook and crash forecast, I’ll keep Boom & Bust and Cycle 9 Alert readers in the market… at least until my micro-signals tell me it’s time we get out.

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Categories: Markets

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.