Dizzying Highs: Stock Market - Economics, Plato and PE - Econ Lessons

[TexasTowelie]

Hi, my name is Mark, and I am an Economist. I use my understanding of Economics, Plato, and PE ratios to analyze today's stock market. Who says my liberal arts education did not pay off? The stock market today presents a highly uncertain environment, and based on my understanding of economics, price-to-earnings (PE) ratios, and leadership assessment, I have decided to stay out. This is not financial advice—just an analysis of why I believe the risk-reward tradeoff is unfavorable in current conditions.

First, PE ratios are historically high, suggesting that stocks are overvalued relative to earnings. Lower PE ratios traditionally signal better entry points for investors, while inflated PE ratios often indicate excessive optimism or speculative bubbles. With interest rates rising and economic growth slowing, earnings could decline, making these valuations unsustainable.

Second, non-free trade policies and tariffs introduce inefficiencies into the market. Tariffs disrupt supply chains, increase business costs, and reduce global competitiveness, lowering profit margins. The more barriers imposed on trade, the more distortions occur in resource allocation, ultimately impacting corporate earnings and overall economic efficiency.

Third, economic freedom in the U.S. is declining, according to global rankings such as the Heritage Foundation’s Economic Freedom Index. Tariffs or protectionist policies and growing government intervention reduce market efficiency and hinder long-term economic growth. Historically, markets in more complimentary economies tend to perform better over time, while restricted economies struggle with stagnation and inflation.

Fourth, political uncertainty and leadership instability contribute to volatility. In investing, confidence in government policy plays a significant role in market stability. If leadership decisions are unpredictable or inconsistent, investor sentiment can swing wildly, increasing market instability. Plato’s philosophy suggests good leadership is rooted in wisdom, honesty, justice, and long-term vision—crucial for a stable investment environment. Right now, the character criterion for leadership does not inspire confidence.

Lastly, I apply the three Cs of credit—character, Capacity, and Capital—as a framework for investing. Just as banks assess borrowers using these metrics, investors must assess the economic and political landscape before putting money at risk. With leadership volatility, economic inefficiencies, and unsustainably high valuations, I believe the conditions do not meet the criteria for a prudent investment.

Again, I am not making any recommendations or giving investment advice. I am sharing my reasoning for staying out of the stock market during these bearish and highly volatile times. My decision has already saved me from potential losses, and I will continue to reassess the market based on fundamental economic principles.

[progree]

1. Yup, only problem is, that people have been saying the market is overvalued since about 2012 and citing

Last edited Sat Mar 29, 2025, 02:25 AM - Edit history (1)

high valuations, high debt loads and a dozen other factors.

In the meantime, the S&P 500, as measured by VFIAX, the Vanguard S&P 500 index fund, has gone up 5.02 fold from 3/13/2012 to 3/13/2025, a 13.2%/year annualized average rate of return. IOW, it's very hard to call tops, but the permabears have been doing it almost continuously throughout market history. Missing out on many doublings and re-doublings for fear of a TEMPORARY 50% or so drop.

https://www.morningstar.com/funds/xnas/vfiax/chart
(click on the the table icon just to the right of the start date, end date, frequency pulldowns to see the actual numbers, so that one doesn't have to try to read numbers from the graph -- they pop up on the graph where one hovers their mouse, but still its hard to position the mouse cursor).

(It's grown 3.64-fold, a 12.5%/year annualized average rate of return, since 3/13/2014 when the "it's a bubble, it's a bubble, it's a casino" chorus was really growing loud around here).

To see S&P 500 performance long term, alongside bonds and T-bills, see http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
(at the moment, 3/13/25 close, the S&P 500 is down 6.1% from that last (12/31/24) closing value)

I'll have to admit that the permabears have a very convincing case rhetorically -- when the market is going up, they say "its a bubble, its a bubble". Then when it goes down, they say, "see I told you so". They are never wrong, but the problem is that they don't have much to supplement their Social Security when they retire and deplete their nest eggs much sooner than long-term equity investors.

Innumerable simulations of different allocation percentages have shown that high equity allocation portfolios (but not 100%) have the lowest risk of running out in the face of withdrawals and inflation over long retirement periods (e.g. withdrawing 4% in the first year of retirement, and increasing the dollar amount withdrawals at the rate of inflation in subsequent years) .

Edited to add 2 weeks later: A related post: How often do stock market corrections occur (down more than 10% from recent high): Answer: every couple of years on average. It has Trump's first term 16.32% avg annual rate of return. Also will over-allocate to equities when the market hits 20% down. And that I made the mistake of panicking in 2020 and I learned a lesson: the right equity-to-fixed-income allocation is the one that one can stick with. Numerous simulations in AAII Journal and elsewhere show that a high allocation in stocks does best against inflation and withdrawals. My reply #4 has the 3 biggest S&P 500 post-WWII plunges: 48%, 49%, and 57% S&P 500 peak-to-bottom. Reply #13 clarifies I don't do individual stocks, and that my scheme of buying when the market is down only works with broad-based funds like the S&P 500 index fund or total market index fund, and I would never make such a claim for an individual stock or even a group of 50 stocks , 3/13/25 https://www.democraticunderground.com/111699904#post1

[Bernardo de La Paz]

2. A contrarian view helps. And remember, bull markets climb a wall of worry.

The "been saying overvalued since 2012" is the wall of worry. People do watch PE ratios

The press in the fall of 2024 and through the market peak in January was ebullient and exuberant, full of "pick these stocks to catch the AI boom", etc.

By February, articles were creeping in about defensive stock picking against tariff taxes, etc. Got more articles about "uncertainty" in March. Then as Friday and Monday rallies blunted the correction, articles became more ebullient again.

I think the press and stocks are still discounting the negative effects of Muck chainsaw, tRump tariff tax, and labour market disruptions, mostly because they haven't begun affecting economic and commerce statistics much yet.