Lofty valuations, volatile markets leave investors anxious
The start of 2018 has seen markets flashing red, with investors questioning the stability of the market. February’s meltdown led to a significant market correction of over 10 per cent. Volatility has become just one of several fears, with the recent technology selloff and fears of a trade war sparking additional anxiousness.
Market valuation, essentially the price people are willing to pay for stocks, is reaching highs last seen before significant share price drops. This is typically measured with the price-to-earnings (PE) ratio – a multiple of how much investors are willing to pay for $1 of earnings. This number has historically averaged approximately 15 times the Dow Jones and S&P 500. Contrast that with the current PE ratios for the Dow Jones and S&P 500: respectively 26.7 times and 23.5 times, or roughly 67 per cent higher than the average.
Markets rebounded in the several years after the 2008 recession and headed towards record highs, while becoming more stable. The Chicago Board Options Exchange Market Volatility Index (VIX) steadily decreased. It has a historical average of about 19 but recently dropped as low as 9.14. A sudden increase in the VIX of over 75 per cent at the start of February led to investors panicking, ultimately leading to its first correction in over two years.
Undoubtedly, markets are reaching uncomfortably lofty valuation levels. As market prices increased, so did total money invested, peaking at nearly $100 trillion globally. As more people invest in the markets, particularly in passive investments such as exchange-traded funds, money managers have had no choice but to continue purchasing overvalued stocks, creating a snowball effect and driving markets even higher.