The Standard & Poor’s 500 index flirted with a 1 percent drop on Thursday before recovering to close down just 0.5 percent on the day. The spike in volatility may be in response to growing investor fears that bubbles are forming in global financial markets.
Fears surrounding stock prices have gotten the attention of the Federal Reserve, where officials discussed the risks stock prices may pose to the U.S. economy during their July meeting.
While the Fed concluded that there are no obvious signs of speculation in the U.S. stock market, a growing number of analysts and economists think share prices have gotten uncomfortably high. While market bulls point to robust corporate earnings, and a healthy U.S. economy, bears see a disconnect between earnings fundamentals and stock prices.
[See: 7 ETFs for a Solid Portfolio Defense.]
“Stock prices are much too high despite the good outlook for corporate earnings,” Moody’s Analytics chief economist Mark Zandi writes in Fortune earlier this month. “The only other time in the past half century that stock prices have been so highly priced was during the tech bubble.”
Zandi’s argument is supported by valuation metrics such as cyclically adjusted price-to-earnings ratio, a favorite metric of Nobel Prize-winning economist Robert Shiller. The CAPE ratio is a measure of market valuation that smoothes out cyclical fluctuations in earnings by incorporating 10 years of earnings history. The S&P 500’s CAPE currently stands at 29.8, roughly in-line with its peak prior to the Black Tuesday crash in 1929. The only other time in history stocks have been more expensive based on CAPE was during the peak of the tech bubble in 2000.
“We’re at a high level, and it’s concerning,” Shiller said in an interview with CNBC in June. “People should be cautious now.”
However, he also said that just because the stock market is high doesn’t mean it won’t go much higher before a correction begins.
Unfortunately, the very nature of market bubbles can make them difficult to spot in real time. But shaky days like Thursday can leave stock investors feeling a bit more vulnerable than usual.
[See: 10 Tips for Keeping a Cool Head in a Market Meltdown.]
To help protect against a stock market valuation downside, Shiller recommends investors look for cheaper stocks in international markets or focus on “low CAPE” market sectors, such as energy (16.7) and financial services (25).
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Stock Market Sell-Off Rekindles Bubble Concerns originally appeared on usnews.com
