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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm answering a very good listener question from Nancy K. in Minnesota, which is, are we in a stock market bubble?
And to answer Nancy's great question, let's just first quickly define what a bubble is. And the definition is certainly subjective. Everyone kind of has their own opinion here, but in general, the term bubble is used when referencing periods of time when stocks or other asset classes, real estate included, have gone up so high in value that the chances of a catastrophic drop are looking more and more promising.
The most recent example that you might remember, it would be the dot-com bubble in the late 90s when the NASDAQ rose 400% in five years, which was quickly followed by the bubble bursting and companies like Cisco and Oracle and others losing more than 80% of their value.
Now, what a lot of people forget is that it took about 15 years for the NASDAQ to get back to its dot-com peak, which it finally did on April 23rd in 2015. Another way to define bubbles or other asset classes are if they're overvalued or undervalued, which can be measured a number of different ways with the most commonly referenced metric being the price-to-earnings ratio or PE ratio for short.
For those that use this metric, a high P/E ratio indicates that a stock's price or an index's price like the S&P 500 is expensive and overvalued. A low P/E ratio would be just the opposite.
So just sticking with the PE ratio here for simplicity's sake, the PE ratio for the S&P 500 during the dot-com bubble was just over 46. And right now, currently, the PE ratio for the S&P 500 is hovering around 34.
Now, for reference, the average PE ratio for the S&P 500 since the 1870s is about 16. And for the last few years here, it's kind of sat around in the low 20s.
So going back to Nancy's question, you all might be concluding that simply just based off of the current P.E. ratio, which again, I'm just using for simplicity's sake. Don't send me a bunch of hate mail telling me why the P.E. ratio isn't a good metric. But just for simplicity's sake, you might be concluding that, yes, it does appear that we're entering into bubble territory and this bubble has to pop soon.
In addition to the S&P 500, as we all know, housing is hitting record highs, cryptocurrency is hitting record highs, government spending is hitting record highs, and interest rates are coming off record lows. So things might be feeling a little bubbly right now.
But let's just push aside valuation metrics for the sake of today's conversation. We could all argue all day long whether or not the PE ratio is reliable and what might be a better predictor of future prices. But for now, let's just all agree that the S&P 500 has been screaming upwards for the better part of 11 years now. And the general sentiment from people I talk to, I hear from is,
that the market has to crash soon. This is crazy to which I immediately say, which market, right? Most people talk about the S and P 500, like it represents the entire global stock market. However,
As listeners of this show know, there are plenty of sectors and asset classes that have not been screaming upwards for the last decade. For example, while the S&P 500 is up almost 200% over the last 10 years, international stocks represented by the MSCI IFA index are only up 80-85% or so. Emerging market stocks have performed even worse than that.
We've also talked at length on this podcast about small cap value stocks around the world compared to large cap growth stocks, which when you start looking at valuation metrics, don't look nearly as bubbly either. So to Nancy's question, which was, are we in a stock market bubble? I would first say, Nancy, I don't know because I don't have a crystal ball and anything can happen in the future. We've seen PE ratios go over a hundred before, but
But, second to that, I would just say, well, which market? Because there are plenty of corners of the market in asset classes that feel undervalued and unloved, which by definition means they have higher future expected returns.
Now, this doesn't mean that it's time to sell all of your S&P 500 ETF and go all in on international and emerging market stocks. It just means that, once again, it's more important than ever to ensure that you have a properly constructed portfolio that's not just comprised of market cap weighted U.S. stocks.
It also means that you have to be careful what you're reading and what you're listening to so that you're not panicked and scared into making an irrational decision with your investments that didn't even relate to your investments. Yes, global stocks will eventually experience a catastrophic drop at some point in the future. I mean, we saw it happen last March during the COVID crash when the stock market dropped over 30%, and it will happen again.
But instead of worrying about when it will happen, because we'll never know, I would just encourage Nancy and all of our listeners to stay focused on the things you can control, which is what we spend all of our time talking about here on the podcast. For today's conversation, that would be identifying how much risk you're taking with your investments, looking under the hood and really understanding how much risk you're taking with your investments and
and exactly how your portfolio is constructed so that you don't have all your money in market cap weighted stocks in the S&P 500, which might start to feel a little overvalued right now.
Thank you, Nancy, so much for sending in your question. If you ever have a question, I'm going to start doing more listener mailbag episodes. You can send an email to podcast at you stay wealthy.com for anyone, any listener that's ever sent me an email, you know, that I read and I respond to every single email that I get. So keep them coming in. It helps make the show better for you. It helps me out, find topics that are of interest to you. So
podcast at youstaywealthy.com if you have any questions. I look forward to doing more of these and thank you as always for listening. I will see you back here next week.