With the past several years of a rising equity market, there is growing concern that markets in general are over-valued and that we may be heading towards a crash. While it is true that the current US S&P 500 has a P/E ratio of about 23, this doesn’t necessarily mean that valuations are overblown. Looking back at past recessions, we can see that watching the markets isn’t actually the best way to gauge whether a downturn is on the horizon. Instead, indicators like the federal yield curve, or the unemployment numbers can paint a better picture.
Prior to the past 7 recessions we saw that the federal yield curve flattened significantly, and in some cases even inverted. Which means that short term interest rates were equal to, or in the case of an inversion, greater than long term rates. As of right now, the current yield curve appears to be healthy with the expectation of rising short term interest rates on the horizon. The jobs numbers are a lagging indicator of the economy, meaning that we tend to see the response after an economic contraction has already begun. During the last recession unemployment peaked at 10.10% in October of 2009, near the end of the crisis.
Overall, the stock market is useful for gauging the business cycle, but with the context of other economic indicators as well. Experienced investors know better than trying to time the market. It is very difficult lesson to learn. Investors should instead, focus on their overall risk and strategy…stick to their investment plan, monitor, and rebalance their strategy during both advancing and declining markets.
As always, please consult with your advisor or investment professional before making changes to your plans.
Wayne L. Locke, CFP® Matson Financial Advisors, Inc.