Does the Stock Market Need to be Massively Overbought Before It Crashes?

I cannot turn on CNBC or Bloomberg without hearing some money management type explain that there is no risk of a stock market crash because it is not wildly overbought like it was in 1929, 1987, 2000 or 2008. It seems that everyone is drinking this Kool-aid at the moment.

While it tastes good, it isn’t exactly right.

The stock market is trading at a 2018 PE multiple of 18x and a 2019 multiple of 17x.

I would submit that a 17x future multiple for an economy that has the appearance of 3% growth is very expensive. (I say appearance because I believe that tax relief generated most of this growth and that it will be rolled back in 2019, even if the Republicans maintain control of both houses of Congress).

The stock market is, in fact, buttressed by some stocks that are incredibly inexpensive on a PE basis. Even some leading technology stocks appear very inexpensive (Apple and Intel, in particular). But, some stocks are terribly out of whack with any sort of reasonable valuation metrics.

The PE multiple doesn’t need to be 20 or 25 or 30 for the market to be irrationally expensive. There is no magic number.

And, market crashes or corrections are caused by a quick change in sentiment when the market is dramatically overbought. In my view, some things that could cause a change in sentiment are: a President who is mentally incapacitated, a trade war with China / inflation, a change in control of the House of Representatives, or an environmental catastrophe.

Massively overbought or just irrationally expensive, there is trouble on the horizon.

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