Money Matters: Market is overvalued
Right now, as I write this, the Dow Jones industrial average is up 25 bps (basis points: one quarter of a percent or .25 percent) on the day. The prior day, it was all over the place, closing up 43 bps (.43 percent). During the past week, it’s declined by nearly 4 percent, and it’s off 3 percent this year.
What’s all this mean? Well, if you ask Warren Buffett, based on his “Buffett Indicator,” the market is heavily overvalued, sitting at 131, on a scale where 115 is considered significantly overvalued. How serious is this? It has gone over 100 only three times since 1970, in 2000 before the tech bubble, 2007 just before the Great Recession, and now.
If you ask people who follow the yield curve, there is more bad news. The yield curve is the relationship between yield on long-term and short-term government bonds. In a normal world, tying up your money for a longer period yields a better return than tying it up for a shorter period. This happens to compensate for the risk that strong growth could set off a broad rise in prices. However, when the yield curve is inverted, short-term debt yields more than long-term, signally a poor long-term outlook. Currently, the gap between two-year and 10-year Treasury notes is about 34 bps. The last time the curve was this flat was in 2007 as we were slipping into a world-wide recession.
Then there is the volatility index, or the VIX, a.k.a. the “fear index.” The bromide goes, “When the VIX is high, time to buy. When the VIX is low, watch out below.” Right now, it sits at around 20 in a range of around 10 to 80. So, while not in the cellar, it’s close. Watch out below.
In the midst of all this, I see headlines such as the following: “Analyst remains bullish on Wall Street amid positive economic indicators,” Yahoo Finance. So, what to do? Are we in a correction, ready to bounce back, or are we at the beginning of a bear market?
Here’s your prediction. It’s the most accurate prediction you are going to get anywhere. You can take it to the bank. In fact, you can use it to plan the rest of your life. Are you ready? Get a pen or pencil to write it down. It’s going to change your life. Here it is. Drumroll…
It will go up. Or it will go down. In fact, it will do both. What it will do next, I don’t know. I haven’t the slightest idea. Nor, despite what all these gurus say, do they. It will depend on the general mood. It will be based on interest rates, our relationships with China, and Canada, and Mexico. It will be based on what the Bank of Cyprus does (remember that?). It will be driven by inflation and tariffs. It will be impacted by the next move from Congress, or the president.
In other words, it could do anything. And it could be triggered by anything. So, the question becomes, how much of your retirement do you want to bet on these unknowns?
So back to my original question. Is this a correction, or is it a bear market? And what should you do about it?
The bottom line is the market is whatever the prevailing mood and conditions dictate. It could be a bear. It could be a correction. Or it could be the beginning of a next bull run, or a continuation of the last. What I would say is it should not really matter. Not if you are managing your assets correctly.
Down markets can kill a retirement. If you have a major market decline within five years of retiring (either before or after) your odds of success go way down. How much? Again, no one really knows. We just know, it isn’t good. However, here are some things we do know. During the decade from 2000 to 2010, the odds that you could live on 4 percent of your invested assets and not run out of money for the average retirement period went from 89 percent to 6 percent, based on a study by T. Rowe Price. According to Morningstar, if you want a 90 percent-plus probability of success, defined as not running out of money, you must limit your payouts to 2.8 percent. But even then, there is a 10 percent or more chance that you will run out. And there is an even greater chance you will die with way too much, in other words, cheating yourself out of the best retirement possible.
Bear or correction? Is this how you want to live your life? Wondering with every downturn whether you should sell or buy? Whether you should hold or divest? Stocks or bonds? I guess it depends on who you talk to.
What I would say is, don’t do any of them. If you are within five to 10 years of retirement or already retired, get at least half your holdings out of the market now while it is still at near record highs. Move your money into a Retirement Income Generator that is contractually guaranteed never to lose value. This will provide a much greater level of income – two to three times as much as the market will yield – and it will never run out. There is no taxable impact from this, and when you finally do depart for that great pasture in the sky, you can leave the balance to your heirs, knowing you have never been a burden, and always had the best retirement your assets could provide.
Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, he services Greater Boston and the New England areas. He can be heard every weekend on the “Free to Retire” radio show on WCAP and WFEA, and he conducts planning workshops at his New England Adult Learning Center, located in Nashua. Initial consultations are always free. You can reach Steve at 603-881-8811 or at www.FreeToRetireRadio.com.