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What Is an Overvalued Market?

An overvalued market refers to when enough stocks become overvalued, either in an industry or across the board, and prices inflate beyond their perceived ‘fair value.’. 

Overvalued markets, explained

“The market” – for our purposes, the securities that comprise the U.S. trading economy – is an unwieldy beast. It’s made up of corporate stocks, government bonds, options, and a plethora of more complex securities. Due to its intricate nature, it’s hard to apply a blanket statement about all market movements.

But some terms can apply to most securities in the broader market. One of these that has come roaring back is that the market is overvalued. And it’s no surprise, either – the U.S. stock market has been trending up for the better part of a decade. 

Most investors are familiar with overvalued stocks – stocks that are trading too high against earnings outlooks or other fundamental factors. Overvaluation may indicate several things, but one thing is for sure more often than not: if the company doesn’t rise to the occasion, the stock will tumble back into reasonable territory instead.

The same is true of the U.S. investment market at large. When the market becomes overvalued, it can lead to real-world impacts on your portfolio.

What causes an overvalued market?

There are a variety of reasons a stock may drift into overvaluation. In turn, many of these extend to the market: if enough stocks or industries experience overvaluation, the market will sway, too.

But what causes an overvalued market in the first place?

  • Investor emotions that can cause illogical, irrational decisions
  • Economic activity like sustained high economic growth
  • Hype and excitement that causes investors to forget the fundamentals. Think the Dotcom bubble in the early 2000s.

What this means for you

When the market is overvalued, there are a few ways you can approach your investing strategy. Ultimately, the best answer is one that includes thinking for the long-term, rather than how to improve your short-term gains. And of course, it’s prudent to keep your financial situation in mind, as well as your short- and long-term goals.

1. Focus on undervalued investments.

If you’re looking to cash in during an overvalued market, you might start with undervalued investments. Just because the market is overvalued doesn’t mean every sector is – just look at Nasdaq’s valuation against the S&P 500.

2. Balance your Portfolio with non-stock assets.

Another way to address an overvalued market is to look outside traditional securities. Bonds, mutual funds, ETFs, and commodities not only diversify your portfolio, but they provide protection against the inevitable drop in valuation. And if you’re feeling particularly adventurous, you can gaze beyond domestic borders to foreign securities.

3. Stick to your plan.

Trying to time the market, beat the market, or otherwise outwit a non-living entity controlled by millions of rational and irrational minds at odds is, in and of itself, an irrational decision. While day-trading and market timing can sometimes lead to big payoffs, most of the time, they come out to average or even below-average returns once you account for taxes and fees.

Disclosures

Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.

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