By: Chris Rowe — January 4, 2022
Warren Buffett Calls This Market “Manic” - Here's Why
It’s 2022 and I couldn’t be more excited! This is going to be a great year.
I know there are many challenges to overcome in 2022. But in terms of making money in the markets, you should fully expect 2022 to be a robust year of growth.
And I don’t mean that the stock market will go straight up this coming year. In fact, I think you can expect the unexpected from the market in 2022.
Warren Buffett describes market mania as a market environment where even seasoned veterans stop thinking about stock valuations, but instead think only about not missing the next insane winner.
In other words, logic and rational thinking go out the window even for the most seasoned investors, and everyone suffers from fear of missing out.
Here’s one reason you should be mentally prepared for market mania in 2022.
Right now price-to-earnings (P/E) ratios are historically way overvalued. I’ll expand on the significance of that momentarily.
But the reason you should still expect a robust year from True Market Insiders is that we don’t care if the market goes up, down, or sideways. Our strategies position you to make money in any market environment.
Volatility creates opportunities. And with such a diverse suite of trading approaches, you don’t need to rely on bull markets to make money.
And—no matter what—relative strength, sector rotation, sector breadth, and trade volume analysis will always be how you should narrow down your search for the best available trades.
Before I talk about the clear disparities you’re seeing in the S&P 500 (P/E) ratios, let me give you a quick refresher on what P/E ratios are, and why they’re relevant.
Let me also say that P/E ratios are a form of fundamental analysis, but I’m going to review them from more of a technical perspective once I finish explaining what they are and why you need to know about them.
Why P/E Ratios Matter
The P/E ratio is one of the most well-known tools of fundamental stock analysis. It’s a very simple apples-to-apples comparison.
The “P” stands for the current share price of the stock. The “E” refers to earnings per share (EPS).
EPS is simply calculated by taking the company’s current profit, and dividing it by the number of outstanding shares of the stock. You can find a stock’s EPS already calculated on many different public financial sites.
Generally speaking, the higher growth that Wall Street analysts expect a company to have the higher a price they are willing to pay for that company or that company’s stock.
For example, companies with higher profit margins have higher potential for long-term growth. It shows that what the company is doing is successful, and is bringing in enough money to keep the firm growing and scaling.
When you divide the current share price of a stock by its EPS, then you get the P/E ratio. A high P/E ratio indicates that the stock has more growth potential, or that the stock is maybe overvalued.
You can actually calculate the P/E ratio for an entire index of stocks. In fact, I’m going to apply it to the entire S&P 500 index right now as we focus on the idea that high P/E ratios suggest stocks are overvalued.
To be clear, just because the market is overvalued, doesn’t mean the bull market is over. We’ve seen the market continue to go up despite a clear disparity in P/E ratios versus fair value a number of times in the past.
The black line on the chart below represents the P/E ratio of the S&P 500 Index (SPX). In a normal market, it would stay close to the blue “fair value” line.
(Click any image to enlarge.)
You can see that in 1997 during the dot-com bubble, the S&P 500 P/E ratio went way above overvalued, but the S&P 500 continued to go up until the peak in 2000.
And then we saw P/E ratios go well above overvalued early last year, and the market still went up.
Anomalies happen. You can see, on the chart below, when normal P/E ratios plummeted during the real estate bubble in 2008. The S&P 500 reported fourth quarter losses of -23.25%. But then it snapped right back up.
At the time, the market couldn’t keep up with the sudden changes hitting our economy. But today, we’re not seeing waterfall crashing action like we saw in 2008. Today, it’s more than just an anomaly.
So, when we see disparities like this, what should we take from them? Well, simply that investors are not investing rationally.
Why would a stock’s price far exceed its earnings? It shouldn’t.
But this is no time to be calling a market top. When the market is making new highs, that is when investors are most bullish.
So, it’s best to wait for additional confirmation of a bear market before getting very bearish in your portfolio.
Until then, you should be hedging your positions, just a little, knowing that this is a very unpredictable market.
As far as making money goes, just follow me. I’ll show you how to take full advantage of the opportunities a manic market provides.
If you’ve made it this far and still don’t know what a P/E is and why it’s important to understand, go ahead and subscribe to my YouTube channel - Here’s the link. I’ll be posting and sending out a video soon on P/E ratios and their importance.
Founder and CEO, True Market Insiders