The last time we talked here, on Saturday, I showed you how, based on price-to-earnings (PE) values, the S&P 500 is now trading at the loftiest level of its 95-year history.

The S&P’s current PE of 31, I noted, tops its 2000 peak reading by a nose.

Moreover, stock market valuations appear even further stretched from the perspective of other common metrics like the price-to-sales ratio, the price-to-EBITDA ratio and the “Buffett Indicator.”

On average, these valuation gauges place the S&P 500’s current pricing about 50% higher than its 2000 peak.

I noted that even the Federal Reserve is calling this market toppy — and is saying we’re due for a “re-pricing event,” i.e., a market crash.

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We got here thanks, in large part, due to a phenomenon known as multiple expansion. That’s when investors pay an ever-rising price for each dollar of underlying earnings.

During the last 10 years, for example, the S&P 500’s PE has roughly doubled — from about 15 to 31. Therefore, all else being equal, the index would be selling for about half its current level if it merely returned to its 2011 PE ratio of 16 times earnings.

To be sure, corporate profits have been growing year by year since 2011, which partly explains the rising stock price trend. But multiple expansion can claim a much larger share of the credit.

To me, that means today’s stock market offers no lack of higher-than-average risk.

In the last Smart Money issue, I said we’d spend the next few days taking a closer look at how we got to this point — and at the many great opportunities remaining in select portions of the market.

Let’s get started …

Buzz Buster

Here’s something else I said on Saturday:

When FOMO [fear of missing out] is the dominant investor sentiment, valuation rarely figures into the investment calculus. Momentum is everything. Momentum and a good story.

No one needs a keen eye for balance sheets or income statements. They simply need enough of an eye to see a rising stock price … and to check out the online chatter that may be powering that stock to ever-higher highs.

They must also have enough bravado to “buy high” and believe they can sell even higher later. Seasoned investors sometimes scorn this practice as the “greater fool strategy” because its success relies on a “greater fool” paying an even higher price than what the earlier investor paid.

But “great fools” can profit handsomely during manic stock market phases. Gains arrive so effortlessly that investing seems as “easy” as boiling water. The easier it becomes, the more folks like to chat about the next “hot stock.”

The r/WallStreetBets crowd on Reddit is one prominent example. This community chats 24/7 about the next hot stock to buy. And as we saw earlier this year, the “buzz” from r/WallStreetBets was more than enough to launch GameStop Corp. (NYSE:GME) shares into the stratosphere … at least temporarily.

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Thanks to the crazed, fist-pumping hype on Reddit, GameStop stock rocketed more than 1,000% in just five trading days — momentarily gaining a lavish $35 billion valuation.

Because of “success stories” like this, a major Wall Street money manager decided to launch an exchange-traded fund that seeks to capitalize on social media chatter. Fittingly, this new ETF goes by the ticker symbol “BUZZ.”

This ETF literally prioritizes “buzz” and social media chatter over any other investment consideration. Perhaps this novel strategy will deliver marvelous results. But the long history of financial extremes suggests otherwise.

Once a stock’s investment merit becomes so widely known that it attracts widespread “buzz,” that stock’s best days are usually behind it … not in front of it. Investors rarely gain an enduring “edge” from trading off of widely disseminated information.

So, I would not be surprised if BUZZ quickly became a “buzzkill” of disappointing financial results and falling stock prices.

Returning from anecdotal signs of stock market froth to empirical ones, we can find a few more phenomena that you will never see at a stock market low.

From Junk to Treasure

First, “junk bonds” have become coveted treasures, as fixed-income investors chase after high yields wherever they can find them. Because of their frenzied buying, high-yield bonds — aka “junk” — are paying the lowest interest rates ever recorded in that market.

The average rate on high-yield bonds recently dipped to a record low of 3.91%. Even the yields on CCC-rated bonds — the junkiest of the junk universe — have dropped to a record low of 5.81%, down from 10% as recently as last October.

In other words, the buyers of these high-risk bonds are receiving the smallest-ever compensation for the risks they are taking.

Junk bonds are not the only “junky” assets attracting robust buying interest. So are lots of “junk stocks.”

According to analysts at Bernstein Research, more than one quarter of U.S. stocks failed to generate positive net income last year — the highest percentage in at least 50 years.

The tech sector was even more profit challenged, according to Bernstein, as 37% of the stocks in that group generated a loss in 2020. And yet, this very same loss-making group delivered some of the stock market’s biggest gains last year.

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It racked up an astounding 92% market-cap weighted return in 2020, which was more than double the 40% return for the U.S. tech sector as a whole.

A unique custom index of the most heavily shorted, highly leveraged companies on the New York Stock Exchange underscores the extent to which “junk stocks” have been producing market-trouncing returns.

In general, these stocks possess such obvious weaknesses that investors are betting heavily on them to fall, by selling them short.

Short sellers are not always right. In fact, they haven’t been “right” about much of anything lately. But as a group, they have a good nose for troubled stocks.

And yet, many heavily shorted stocks have been soaring. And because they’ve been going up, investors buy them more aggressively, which makes them soar even higher.

Before you know it, heavily shorted stocks are racking up a 300% gain in little more than a year, compared to a gain of 80% for the overall S&P 500 Index.

Again, you don’t see phenomena like these near a stock market low.

So, what should we investors do with these insights? Should we run for the hills or cower under our bedsheets?

Probably not. But we should exercise some degree of caution … even while continuing to invest in new opportunities. Successful investing always requires a balance between trimming some risks, while still embracing others.

That’s exactly what we do in my Fry’s Investment Report service.

For instance, we recently closed out three positions that were socked by the recent market turbulence — for average gains of over 100%. And in the latest monthly issue of the Investment Report, I recommended a beaten-down stock in the industry that I believe has the most to gain in 2021 as we climb even further out of the pandemic.

To learn how to get that recommendation as a member, click here.

In keeping with the bullish zeitgeist that BUZZ epitomizes, in the next Smart Money we’ll take a look at some of the personality cults that are popping up like champagne corks on New Year’s, just like they always do during ripsnorting bull markets.

I’ll see you then.

Regards,

Eric Fry

P.S. Hundreds of thousands of folks saw my “Technochasm” viral video from earlier this year.

Well, the whole world has changed since then … and I’m back to talk about the Technochasm, the biggest megatrend in investing, in ways I couldn’t before … and discuss opportunities for even bigger market gains… the kind to keep you from falling behind. And I’m bringing along investing legend Louis Navellier to join me on camera for the first time ever.

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On the date of publication, Eric Fry did not own either directly or indirectly any positions in the securities mentioned in this article.

Eric Fry is an award-winning stock picker with numerous “10-bagger” calls —in good markets AND bad. How? By finding potent global megatrends… before they take off. In fact, Eric has recommended 41 different 1,000%+ stock market winners in his career. Plus, he beat 650 of the world’s most famous investors (including Bill Ackman and David Einhorn) in a contest. And today he’s revealing his next potential 1,000% winner for free, right here.