Let’s take a look at current market valuations (high) and what they are telling us about probable 10-year forward returns (low). The stock market has had an outstanding five year run. With that, I believe, many individual investors have misguided expectations. The market is overvalued, over-believed and over-margined yet trend evidence remains positive and Don’t Fight the Fed an important theme. For now.
One of my favorite valuation measures is median PE. It is based on actual reported earnings (not Wall Street’s oft over-inflated forward estimates). This first chart shows median PE to be 21.5 (price times earnings) on April 30, 2015. The 51 year average median PE is 16.8.
Note that in the upper left of the chart that the Median Fair Value (taking current earnings times 16.8) is a S&P 500 level of 1627.24. The market is at 2121 today and was at 2085.51 at April month end.
Overvalued is measured at a 1 standard deviation move above Fair Value or S&P 500 level 2128. We are a long way away from undervalued or S&P 500 level 1126.29.
The next chart looks at S&P 500 PE based on (normalized earnings). The current reading is 20.3.
The data in the box in the upper left of the charts shows the S&P 500 Gain/Annum when this PE measure is above 16.5 (shaded grey). It shows that PE has been above 16.5 about 30.7 percent of the time since 1927 and over that time period the return averaged -0.5% when PE of 16.5 or higher.
We are in a high valuation = low return zone. Stocks are richly priced.
For the full story see On My Radar: Valuations and Forward Returns.
The objective behind all of Steve Blumenthal‘s work is to help advisors build better portfolios by allocating with a long term game plan that is risk sensitive and properly diversified. Mr. Blumenthal is a self-proclaimed “quant geek” with an analytical mind for the markets that helps him connect with everyday investors and industry experts alike.