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Is the US Stock Market Overvalued?

June 18, 2020 By Mircea Vasiu

The US stock market participants concentrated on two sides during the COVID-19 pandemic and following massive central banks’ intervention. 

On one side, experienced managers, backed by years-long market performance, warn that the market is way overvalued. On the other side, a new breed of traders, the retail day-traders, meet the market for the first time via fractional shares from brokers like Robinhood. They are the buyers, and their volume is big enough to influence market moves.

Which is more important – the voice of reasoning and experience, or the voice of young, adventurous investors?

US Equity Market – Between a Pandemic and an Election Year

According to the Merrill Lynch Fund Manager Survey, the equity over-valuation composite indicator just reached levels that have not been seen in over two decades. It means that a record number of managers and Wall Street veterans believe that the US stock market is overvalued, arguing that the recent rally from the bottom doesn’t seem like the bottom is in place – it differs from the 2003 or the 2009 bottoms.

Similar values (even smaller) for the indicator were last seen before two important market U-turns – in 1999 before the tech crash, and again in 2017, right before the trade war with China began. Therefore, experienced traders are reluctant to invest in the stock market at the current valuation levels.

On the other hand, for the new generation of traders, the stock market replaced the sporting bet market that closed during the pandemic. Because of fractional sharing, traders can invest any amount in one stock, and the broker converts it in fractions of a share or shares. Due to the large number of new traders, this volume is significant, even if the individual trading volume is relatively small.

One explanation is that for the new generation of traders, the amount risked in the stock market is not that relevant. Most of the money is, anyway, free money as it came in the form of help from the government, so losing it is not the end of the world. After all, how can one explain the rise of Hertz’s shares just hours after it declared bankruptcy?

While there is an upbeat cyclical stance in equities, the return potential has diminished, especially if we consider that we are in a presidential election year in the United States. We are going to find out soon enough what type of investors prevailed – the cautious or the more adventurous?