Analysts have identified a few key warning signals in the market that should give investors cause for cautionary concern. Primarily, strategists are growing concerned that stocks are overvalued, and there is evidence to back up these concerns.
Due mostly to overpriced IPOs and an all-time high S&P 500 price-to-sales (P/S) ratio, some analysts are starting to warn investors that they should adjust their expectations for returns in the coming months.
S&P 500 Price-to-Sales Ratio Hits All-Time High
One major sign that stocks are overvalued is the S&P 500 price-to-sales ratio, which recently hit an all-time high of 18.6.
According to data from Ned Davis Research, the S&P 500 price-to-sales ratio is “well in excess of what they were in 2000 or 2007 at those peaks.”
Moreover, the price-to-earnings ratio paints a similar picture. Over the past decade, the average ratio was 14.9, compared to a recent ratio of 18.6. Similarly, the median price-to-earnings (P/E) ratio indicates that the S&P 500 is overvalued by approximately 30%.
Ned Davis Research noted that “the S&P 500 could be overstating earnings due to buybacks and other financial engineering of profits,” and “P/E ratios are some 80% above the long-term norm.”
Unfortunately, the valuation reality was shattered the moment the Federal Reserve began implementing its variations of quantitative easing (QE) since the 2008 recession. One could argue that the Fed’s repo rescue operations since September, which have pumped billions of dollars of liquidity into the markets, are driving markets to all-time highs.
As the old saying goes, “don’t fight the Fed.” As long as the U.S. central bank and others around the world continue to maintain an easing and accommodative policy posture, it should help continue to support the bull market. However, the valuation and the potential impact from long-term Fed easing policies are concerning.
Overpriced IPO Trend Might Spell Market Danger
Another significant market warning signal is the flurry of overpriced IPOs that continue to pop up. Investors have consistently bought into the hype surrounding big IPOs, inflating prices based on optimism rather than facts.
According to the Wall Street Journal (WSJ), the last time the market saw so many money-losing IPOs was right around the dot-com bubble in 1999. The WSJ also noted that over 40% of these IPOs come from the healthcare sector while 17% come from the technology sector.
Portfolio manager for AdvisorShares Ranger Equity Bear ETF, Brad Lamensdorf, indicated that this happens “because investors have lost their sense of reality. They are willing to buy stocks on hyped stories instead of the facts.”
Essentially, as long as investors are willing to take on risk, then investment bankers are perfectly willing to play along. Due to these market warning signals, it might be time for investors to start tempering their expectations as analysts expect modest gains in 2020.
Article By: Connor Beam