Friday, 20 February 2015

The U.S. Stock Market Is At Its Most Overvalued Level In History

By Pater Tenebrarum

We frequently run across assertions that the US stock market is allegedly "cheap," because the trailing P/E of the S&P 500 Index has not yet reached the dizzy heights of 1929 or 2000 (of course, quite often the "forward P/E" is cited rather than the trailing P/E. We believe this to be a worthless indicator, as it relies on overoptimistic analyst estimates that are continually revised lower as time passes).

Apart from the fact that the valuation peaks of the two biggest stock market manias in history hardly represent a useful yardstick for determining whether the market is attractively valued or not, these assertions are focused on an index that is capitalization weighted and the average P/E of which is greatly influenced by a small number of momentum stocks. In 2000, the extreme valuations accorded to technology stocks ended up producing a trailing P/E for the S&P 500 in cloud cuckoo land - however, the market as a whole was actually noticeably cheaper than it is today.

We have already mentioned a few times in the past that the market has never sported a higher valuation in terms price/sales as well as in terms of the median P/E. Dartmouth University Professor Kenneth R. French has calculated the US stock market's median P/E. We were previously unable to find a chart for it, but have now come across a chart that was published by Bloomberg a little while ago, which we reproduce below. Note that the median valuation is even higher at the moment, as the calculation is apparently only performed once a year in the summer months. So the chart depicts the situation as of July 2014.

Only companies reporting a profit are included, so it would be more precise to state that this is the median P/E of the market segment with positive earnings. For comparison purposes, the S&P's P/E ratio is shown as well. What is interesting about this is that the median P/E is currently actually higher than that of the S&P 500 on a trailing basis - something that has never happened before.