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Double Bubble Toil and Trouble

July 16, 2014

With the stock market continuing to climb higher with no signs of slowing down, you can't help but wonder that the party could end soon. Now I don't want to be accused of fear mongering, and I'm not saying that a bear market is just around the corner, but I think it would be wise to take caution.

Dr. Robert Shiller's P/E ratio, which measures the valuation of the market, is at 25.9. The highest its been was 44.2 during the dot com bubble, and we are no where near that of course. However, the historical mean is 16.6 and the regular P/E ratio accepted, before an asset is considered overvalued, is 20. This tells us that the market is overvalued at this time. But let's put things into a little more perspective.

The market hasn't seen a correction, or 10% decline, within the last five years. Corrections, and even bear markets, are good for investors because it makes assets such as stocks more affordable. Janet Yellen, chairwoman of the fed, has said that the economy still isn't where it should be, but we are still seeing the market climb ever higher. At the time of the stock market crash in 2007, we saw a Shiller P/E of 26.80. We're getting pretty close to that level today. Again, I'm not saying that we are going to experience the same kind of crash, I'm just saying we need to be cautious and welcome a correction.

If we continue to disregard the overvaluation of the market and keep pouring our money into, we may enter into the irrational exuberance Dr. Shiller talks about in the video below.

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