After a loooooong hiatus due to tax season, recovering from tax season and just being very busy with work, I am back and hope to resume twice weekly posts. On multiple occasions over the past year I have written about how so many asset classes are overvalued. It is time to put those concerns into numbers.
Here is how much the U.S. stock market, as measured by the S&P 500, would have to drop to get back to normal levels.
Bonds are in a bubble too. If the 10 year treasury bond, currently yielding 2.25%, were to rise to its average rate of 4.58%, then a $1,000 bond would fall in value to approximately $816 (a 18% drop). For a 30 year government bond currently yielding 2.92%, a change to the average of 5.29% would cause a $1,000 bond to fall in value to approximately $647 (a 35% drop!).
Finally, using the Case Shiller Home Price Index, if home prices were to go back to their historical levels, adjusted for inflation, then it would result in an average price decrease of 21.8%.
This all goes back to risk tolerance and investment strategies. Money that is invested now is unlikely to have a significant rate of return over the next few years and is quite possibly going to suffer a 20-50% loss at some point soon. As a result, it is very reasonable to focus right now on debt repayment and building a cash reserve. As Warren Buffett says, holding cash gives you the right to buy any other asset in the future. Although interest rates on money market accounts and CDs are very low, what you are really gaining with those investments is that flexibility to seek a better risk/reward investment opportunity down the road.