The data and story backing up this claim
Stocks have been negative for all of 2022. They've been beaten down, dragged through the mud, and made many of us investors look silly.
But with one month left in the year, things are changing. Stocks have rebounded, and the data shows now is a good time to invest.
The Story
We saw in 2020 — 2021 that risk was being mispriced. Investors were putting money into speculative investments without much concern for how risky they were due to the easy money policies at the time.
In 2021, risk was being mispriced as too cheap. Now, risk is being mispriced as too expensive.
At the bottom of a market, safety becomes overvalued and risk becomes undervalued. This is where we were a month ago and starting to crawl out of.
The story and psychological aspects are important; you need to have conviction in your beliefs. But you also need data to back up your theories.
Historical P/E Ratio
The price-to-earnings (P/E) ratio is a ratio to see if a stock is overvalued or undervalued. As the name suggests, it looks at the stock's price over the company's earnings.
When looking at the general stock market, look at the P/E of the S&P 500. A high P/E number means the stock is overvalued, whereas a low P/E number implies the stock is undervalued.
The current P/E of SPY is a hair over 21. Knowing the current P/E is only helpful when we have information on what it historically is.
Monthly P/E data back to the 1870s is available — but the economy was vastly different then. Using that data to compute an average would skew the results. I looked at the median of the SPY's P/E going back to 1971, 1980, 1990, and 2000.
You can see the trend below. Including data only from 2000 to today, the median P/E is higher than data from 1971 to today, as investing and risk are approached differently.
Data frommultpl
The current P/E is 21.13. This is below the median going back to both 1990 and 2000. The market is undervalued more now than the average time from 1990 to today or 2000 to today.
I see the 21.13 ratio as a sign to start putting more money back into the market. For reference, the median P/E using only 2021 monthly numbers was 26.63. As we all saw, that market was overvalued.
Two months ago (October 2022), the P/E was 19.38. Anything under 20 is a good sign the market is undervalued and should be invested in.
Moving Averages
I've spent all of 2022 looking for signs we were entering a recession, that I neglected to look at signs of when to invest. When it comes to the stock market, it will always bottom before the data looks good.
I don't partake much in technical analysis, especially in the short term. But a good indicator to look at is the 50-month moving average.
Below is SPY going back to 2019. Each candle represents one month. The pink moving average line below the candles is the 50-month moving average.
Notice how we are almost always above the line. And more importantly, the only times we have touched the line, we've been around it for two months and then the market ripped up.
TradingView
March and April 2020 are the two months that went below the 50-month moving average. That was the beginning of the pandemic and the market exploded afterward.
October 2022 is another example of when we went below the 50-month moving average, although the month did not close below it.
And as we've seen, the market has already started rebounding since October. The low in October was $357, and we are now at $407 — a 14% rebound.
Outside of these two occurrences, we’ve been above the 50-month moving average consistently since 2011.
The Federal Reserve
An important part of the stock market is the Federal Reserve's policies. After raising rates by 0.75% at the last four meetings, they are slowing down.
The Fed is expected to raise interest rates by only 0.50% during their December meeting. Several Federal Reserve members have already expressed that they anticipate interest rates will rise by 0.50%, including Chairman Jerome Powell and others.
Once the Fed signals it is slowing down rate increases, expect Wall Street to celebrate. The belief of slowing rates might already be priced into the stock market, as we've seen the market is up significantly from the Fed's early November meeting.
Inflation Data
The stock market is concerned with recent and future data, with a heavy emphasis on the future. So while inflation is elevated and has been high for months, what is considered important is the low readings we've had in the last few months and the belief that the low readings will continue.
BLS
There was a stretch from October 2021 to June 2022 where consumer prices increased by more than 0.5% for every month except one. It's a good sign that recent increases have all been below that.
Let's hope these recent low recordings aren't "transitory."
Final Thoughts
We know 2023 might be aneconomic hurricane; when that comes, we'll reassess with the most recent data. But today, things in the market are looking promising and the current data is showing it's a good time to invest.
(I'm not saying to dump all your money in the market tomorrow. The VIX is currently just below 20; as
Sam Warainpointed out, that is usually ashort-term signal to sell. [Sell stocks when VIX is under 20 and buy when VIX is above 30.])
I still stand bydollar cost averaging. In recent months though, I have decreased the amount I've been dollar cost averaging in. Based on what I am seeing and hearing, I plan to increase the amount I put in.
In hindsight, it would have been great to do so in October. But timing the market is impossible. Here's to 2022 ending on a high note and getting ready for 2023.
$S&P 500(.SPX)$ $NASDAQ(.IXIC)$ $DJIA(.DJI)$
Follow me to learn more about analysis!!
Comments