US Stock Market Valuation

I do not invest in the US market right now, but I do look at the fundamentals of US as a value investor.  One of the parameters I often refer to is the P/E ratio.

The P/E ratio for the trailing 12-month earnings right now is 19.86.  If we take the historical average of 15 as being fairly valued, the US market is 32% overvalued over its historical norm.

If we look at Shiller P/E ratio which takes 10-year average earnings, the figure is 26.5.  The historical average of Shiller P/E is about 16.  That would mean by that standard, the market is now 66% overvalued.

While the P/E ratios have considerable forward-looking predictive value, markets are also pretty noisy in nature.  It’s unknown when the current bull market in US stocks will end.

A bit of a financial history, the dot-com bubble peaked in 2000, the real-estate bubble peaked in 2007.  So peak-to-peak it lasted 7 years.  7 years have lapsed since the previous peak in 2007.  The question is – is the US market at a peak right now?  Only God knows.

As a counter argument against the above, yields on bonds right now are also at record lows.  Since bonds compete against stocks for capital, that will mean that stock prices are not as unattractive as they look.  Given the lack of alternative outlets, stocks should rightfully trade at a premium to historical prices.  As to how much of a premium it should justifiably trade, let us evaluate.  At a P/E ratio of 19.86, that would mean an earning yield of 1/19.86 = 5.0% for stock.  The 30-year treasury bond now yields 3.1%.  Is that earning delta reasonable?  You’ll have to be the judge.  Of course, if bond yields revert to its historical average (which is higher), it’ll exert downward pressure on the stock prices.

Do tread carefully in this field.

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