Guesstimating The Level Of Froth In US Stocks

Calling tops and bottoms in the stock market is the Holy Grail for investing analytics. Alas, success on this front is nearly impossible, at least in terms of timely precision. Yet some of us still venture down this path. Why? Developing perspective helps, even if it’s less than perfect perspective and it’s used judiciously and the caveats are recognized.

The main caveat is summed up in the warning that the market can stay irrational for longer than you can remain liquid. History, after all, is replete with examples of markets that appeared “over-valued” and continued to set new highs, sometimes for years.

Why, then, make the effort to evaluate market conditions in search of clues about future returns? One reason, and one that I find compelling: tracking what appears to be the market cycle is a useful reminder that risk is non-stationary. Another aspect of engaging in this type of analysis is that it forces you to consider your risk tolerance and decisions related to your investment choices, asset allocation, etc.

With that in mind, let’s check in on an effort to quantify so-called bubble risk for the S&P 500 (for details, see this post). There are many ways to approach this task and the chart below is but one flavor. The current reading suggests the S&P 500 is overextended.

In fact, that was also the message in early March, when I ran the same analytics. How did that signaling fare? Results are mixed, at best. The following month the market corrected sharply, but has since resumed an upward run and is now close to reaching a new high.

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The frothy picture noted in the chart above finds corroboration in other metrics, such as the CAPE ratio. The question is what, if anything, investors should do in light of the general view that the market seems to be fully valued, if not overvalued?

One answer is to pair longer-term valuation estimates with shorter-term trend profiles. Each is valuable for different reasons for different time horizons. It’s not unusual that one contradicts the other, which applies to current conditions. Indeed, as the chart below indicates, the S&P 500 trend remains bullish. After a brief correction last month, animal spirits have rebounded.

The value

GameStop, AMC decline as meme stock rally fizzles after just two days

A GameStop store operates in a strip mall in Chicago on March 16, 2023. Scott Olson | Getty Images

GameStop and AMC shares fell in premarket on Wednesday as the meme stock trading frenzy showed signs of fizzling.

Brick-and-mortar video game retailer GameStop fell 13%%, while movie theatre chain AMC dropped 12%.

The meme stock craze resurged on Monday, seemingly reignited by a rare social media update from “Roaring Kitty.” The man, whose legal name is Keith Gill, posted a picture on the X social media platform of a video gamer sitting forward on their chair — a meme used by gamers to indicate they are taking the game seriously.

Gill, also known as DeepF——Value on Reddit, is a former marketer for Massachusetts Mutual Life Insurance, who previously led a host of day traders piling into GameStop back in 2021.

The return of the meme stock phenomenon brought GameStop and AMC shares up over 70% on Monday, with the stock extending gains into Tuesday. Enthusiasm appeared to be fading by the close of the previous session.

Speaking on CNBC’s “Street Signs Europe” on Tuesday, Smead Capital Management CEO Cole Smead described the meme stock craze as “frankly stupid.”

“It is gambling,” he said.

— CNBC’s Yun Li contributed to this report. 

CNBC

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