Stock valuations are high, the financial media has been reporting lately. This is a topic I examine frequently and it is the subject of my recent weekly commentary On My Radar.
Over the course of the first quarter, Standard and Poor’s lowered its forecast for 2015 earnings from $135 to $112 to $110 per share. With prices already high relative to corporate earnings, such a trend is not an investor’s friend.
Let’s take a look at current valuations and see what they may tell us about the market’s return over the next ten years. Hint: it’s very low. Be prepared to adjust your sails.
The following chart, courtesy of Ned Davis Research, shows the market to be richly priced. Median P/E is my favorite valuation indicator.
Note that fair value on the S&P 500 at 1600.42 as indicated by the orange arrow. The S&P is overvalued at 2093.14 (the S&P 500 index is at 2100 today). Undervalued is at 1107.71. I think those levels pretty much shape out fair value and risk and reward. Though the market may move higher, ultimately valuations will win. Remember, we want to be buyers when upside return is greatest.
source: Ned Davis Research
In this next valuation chart, note the return history three months to two years later when the price to operating earnings ratio is greater than 18.2 (orange highlight). It’s best to be an aggressive buyer of equities when the price to operating earnings ratio is less than 8. It currently stands at 18.39 as of March 31, 2015. Here too the market is expensively priced.
By the above measure, the market is fairly valued at 1613.51, overvalued at 2046.41 and undervalued at 899.52 (that is a scary S&P 500 level).
For the full story read On My Radar: High Valuations = Low Forward Returns. For more on this topic see my Forbes article Stock Market’s High P/E Suggests Lower Returns Ahead. Follow me on Twitter @SBlumenthalCMG.