Tuesday, May 13, 2014

Why is the Stock Market so High?

The stock market, as measured by the Dow Jones and SP 500, closed at another record high today.  That causes many people to ask:  Why is the market at all time highs?  Is it overvalued? Will it crash soon?

As to the first question, there is some debate as to whether the market is high.  Yes, it is, in dollar terms, higher than it ever has been.  But, if you take into account inflation, it isn’t as high in “inflation-adjusted” terms as it was a few times in the past. 

More importantly, there isn’t really a perfect measure of what “high” means.  It is only in terms of price, or a percentage of what companies earn (the P/E ratio).  Or you can look at the P/E over the last 10 years (CAPE ratio.)  You can find justification for just about any position you want.  

The Stock Market is High

If you accept that it is high based on the price, there are possible explanations.  I prefer the simple supply and demand explanation.  In basic economics, when there is more supply for a good, the price drops, and vice versa.  When demand for a product goes up, the price goes up. 

Right now, there is a bit of reduction in supply because companies are going private, fewer companies are going public, and public companies are buying back shares at an increased rate. 

I tend to think the big difference relates to increased demand for stocks because of low interest rates.  If an investor has money to put to work, his options are limited.  He can only get 2.6% on a ten year bond.  Other options, like real estate or gold, are less liquid.  That is, harder to get money out in a short time. 

Therefore, more money is pouring into stocks, many of which pay a dividend, and have recently gone up. 

So, why is the stock market high?  Because like Richard Gere in An Officer and a Gentleman, “(it’s) got no place else to go. “

As always, nothing here is meant to be a recommendation to buy or sell securities. 

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