Median PE was at 23 at May 2016 month-end. That is higher than it was in 2007. The notable exception was in the late 1990s and early 2000s following the tech bubble. While PE is a poor timing measure, it is a very good estimate of forward returns.
This chart shows the S&P 500 Index to be -27.2% away from fair value. It also looks at standard deviation moves. A 1SD move happens but not often as you can see in the history dating back to 1966 (red line in the lower section of the chart). Given the May close in the S&P 500 Index at 2,096.96, this chart shows the market to be 4.9% overvalued.
Note the red, yellow and green light icon. I put that in to simply identify the risk rewards. The arrows in the bottom section highlight “overvalued, fair value and bargains.”
This next chart selects several dates in history. It looks at what Median PE was at a particular month- end and then shows what the subsequent 10-year annualized return turned out to be.
At a current Median PE of 23, we are at the highest level since the early 2000s and higher than the 12-31-2015 number. The next chart shows the average data 1981 through December 2015. Same message. Expect low forward returns when valuations are high.
I’ve shared this next chart with you recently. Here is what GMO is saying about returns over the next seven years:
Whether we look at price to sales, price to operating earnings, price to Shiller earnings, price to forward earnings, price to book and most other measures, we find the same conclusion. The market is richly priced. That doesn’t mean it can’t go higher short term; it does mean that 10-year forward returns are likely to be low and downside risk is high.
If “suffering comes from having an argument with reality,” as the Buddhist proverb states, let’s not argue with reality.
By Steve Blumenthal | For the rest of the story see On My Radar: Float Like A Butterfly, Sting Like A Bee.
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.