Most typical college students spend their time studying, participating in clubs, and hanging out with friends. Yet, there is always a group of students out there eager to make some money. For those interested in a deeper understanding of the market and figuring out which stocks or currencies to invest in, or to avoid, this article may be beneficial to you.
If you invested money in the U.S stock market this past year, you probably earned a nice return on that investment, despite fears of a post-election slump. Since January, the Dow Jones Industrial Average has reached five 1000-point benchmarks, the most in a single year since the creation of the index. The S&P 500 recently surpassed 2600, also a new milestone. You might think that you’ve been so successful this year, that you’re ready to start your own hedge fund. But, if you ask anyone from a Wall Street analyst to someone with minimal knowledge of the U.S stock market, most will agree that stock prices are extremely high today, and perhaps overpriced, which is concerning for any investor. So, before you invest your entire life savings in the market, it is important to understand that equities have climbed to new highs and investing in equities is starting to become very risky. So, should one stay away from stocks right now, and look for alternatives?
Two notable metrics used to analyze the current valuation of the stock market are the cyclically adjusted P/E ratio and the trailing P/E ratio. Robert Shiller, a winner of the 2013 Nobel Prize in Economics and professor at Yale University is known for his development of the Cyclically Adjusted P/E Ratio (CAPE) in 1990. The CAPE ratio calculates the price of the S&P 500 divided by its average earnings over a period of 10 years, adjusted for inflation, and is used to value the market and predict potential returns. In simpler terms, the ratio is the current price of a stock, divided by its average earnings over the last ten years. If a ratio is relatively high compared to similar companies, it means that the stock price may be overvalued. On the other hand, if the ratio is relatively low, it may signal that the stock is undervalued. When attempting to value the entire market, one may look at the prices and earnings of all the stocks in the S&P 500, to try and get a general sense of the economic situation. It is important to note that the CAPE ratio has averaged 16.8 since the creation of the S&P 500, and only on Black Tuesday in 1929 and at the peak of the dot-com bubble in 2000 has the multiple climbed above 30. Both situations resulted in a major market downturn. The CAPE ratio currently sits at 31.6, which hints that the market is due for another correction. However, some argue that the ratio is not a good metric at the present time because it factors in the collapse of the housing bubble in 2008, which skews the CAPE ratio. Perhaps the classic P/E ratio may offer a better picture of the current economic situation.
The Classic P/E Ratio, also known as the Trailing P/E Ratio, differs from the CAPE ratio by using one year’s earnings rather than a full decade’s worth. It currently sits at a multiple of 25, almost 10 points above its historical average. Right now, people are willing to invest $25 in the stock market in order to earn $1 per year. Perhaps, people should turn to risk-free bonds. To one’s surprise, bonds may be a factor in the inflated stock prices. Right now, the Treasury yield sits at historic lows and offers almost half the return of stocks. It seems as if investors don’t have a great place to turn. I must include that many argue that the classic P/E ratio is not a great indicator of the market, either, since one year may not be enough to understand the conditions of a company. Although the P/E sits at 25, it is still far from the peak of 123.73 (housing bubble) and 43 (dot-com bubble). Nevertheless, P/E ratios never seem to stay so far above average for such extended periods of time.
In order for the market to return to its average, one of two things must happen: either the price of stocks must come way down, or earnings must enjoy continuous increases. When looking at historically high P/E multiples, the first scenario seems much more likely than the second.
With stocks at record highs and bond yields and interest rates at record lows, investors have few good options. This brings up the possibility of investing in Bitcoin.
Bitcoin, a digital currency not regulated by the government and also untraceable, seems like a great alternative to stocks and bonds. Most people are intrigued by Bitcoin but are reluctant to invest in it. Perhaps, it’s because Bitcoin is highly speculative and the price has been exceptionally volatile.
Robert Shiller, is his bestselling book, Irrational Exuberance published in 2000, famously predicted the dot-com bubble. Shiller is also renowned for predicting the housing bubble a few years later in 2003. It is, therefore, worthwhile to pay attention to his thoughts on when the next bubble may occur. When asked about the best current example of irrational exuberance or speculative bubbles in an interview, Shiller quickly explained that it was Bitcoin. He believes the reason Bitcoin is up more than 1000% this year is mainly that of the speculation, mystery, and interest surrounding it. If you purchased 100 bitcoins for $10 in 2010, you would be a millionaire today. Shiller explains that Satoshi Nakamoto, a supposed genius, invented the cryptocurrency called Bitcoin. Once people saw that Bitcoin’s investors were profiting from this phenomenon, they became intrigued by the cryptocurrency. Satoshi Nakamoto, as it turns out, is a totally fictitious creation and the true identity of the inventor remains unknown. This only adds to the mystery and intrigue of Bitcoin. It is clear that Bitcoin follows the perfect pattern of a bubble. It can even be compared to the tulip mania that swept through the Netherlands in the 17th century when people decided that tulips were worth the same price as their houses, only to realize one day that tulips were just pretty flowers.
Similarly, because of the mystique of Bitcoin, speculators have caused prices to skyrocket. Is a single Bitcoin worth $100,000, $10,000 or $0? According to Robert Shiller, it’s fundamentally worth nothing. That being said, is Bitcoin a good investment today?
Although the economy is robust, it seems there is no clear-cut option for where best to invest your money. Shiller’s CAPE ratio and the classic P/E ratio show glaring warning signs that the stock market may be significantly overvalued. Bond yields sit at record lows and don’t offer much incentive for long-term investment. Lastly, Bitcoin is the most speculative investment since the dot-com bubble, and we all know how that ended. So, where does that leave us college students with a drive to make money but no real investing experience?
Although I am no expert, I would advise that people do their due diligence before making any investments. Check out companies whose products or services are in demand and have the potential for future growth. Do your research and pick companies that are financially stable and have a high intrinsic value.
The advantage of investing when you’re young, means you have time to ride out the storms. You can’t time the market, so proceed with caution, and bear in mind that historically the stock market has been the best source of return on investment.
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