March 23 2016
There is ongoing debate about whether markets behave in rational ways.
The efficient market hypothesis suggests it’s impossible to outperform the stock market because current share prices reflect all relevant information. In other words, stocks should always trade at fair value and it should be impossible to invest in a stock that is overpriced or underpriced.
The Economist reported there are two issues efficient market theorists have trouble explaining. The first is market bubbles, “where entire markets get out of whack with traditional valuation measures and then collapse.” The other is pricing anomalies. For instance, value stocks are inexpensive relative to their asset values and tend to outperform over the long term. In a perfect market, pricing anomalies shouldn’t occur.
During the past few weeks, U.S. stock markets have recovered from losses suffered earlier in the year and moved into positive territory for 2016. The shift into positive territory has some suggesting markets may not be correctly priced, but there is disagreement about whether it currently is overvalued or undervalued.
According to Barron’s, the recent strong performance of U.S. stock markets hasn’t been inspired by sound decisions and rational economic behavior. “The market’s valuation, at 17 times consensus analyst earnings-per-share estimates for 2016, looks stretched again, given that easy monetary policy and rising oil prices – not earnings growth – are responsible.”
Wharton Professor of Finance Jeremy Siegel disagreed. “On an absolute basis [the stock market is] slightly more highly valued than average but relative to interest rates, which are extremely low, it is actually undervalued in my opinion.”
Investors who believe markets perform well most of the time, but not all of the time, may want to take opportunities like these to look for companies whose shares may be mispriced, as well.
- Data as of 3/18/161-WeekY-T-D1-Year3-Year5-Year10-Year
- Standard & Poor’s 500 (Domestic Stocks)0.0140.003-0.0240.0970.0990.046
- Dow Jones Global ex-U.S.1.6-1-11-1.6-0.9-0.3
- 10-year Treasury Note (Yield Only)1.9NA223.34.7
- Gold (per ounce)-117.99.1-7.9-2.58.5
- Bloomberg Commodity Index12.8-17.8-16.3-13.3-6.6
- DJ Equity All REIT Total Return Index188.8.131.521.86.3
*Indices are unmanaged and investors cannot invest directly in an index.
*Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association
*S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT Total Return Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.