When you see the stock market swing up and down it’s easy to forget that there are actual fundamentals attached to stock prices. At this moment in time, stock market valuations are extremely stretched and nowhere is this as apparent as with the cyclically adjusted P/E ratio for the S&P 500, which just managed to go above 35, a level only surpassed in 2000.
As you can see the CAPE ratio is now above its high of 1929 and way above its peaks of 1987 and 2008. In case you don’t know this ratio was created by Robert Schiller and is a ten year average of the S&P 500 P/E ratio adjusted for inflation. Most people only look at one year P/E ratios, but when you do that these ratios can go up and down so much in any given year that they become statistically meaningless. By using a ten year average Schiller smooths out these swings.
This makes it easier to see where stock market valuations now in a historical perspective. This ratio is not an exact prediction tool, but it is a major tool for those that are looking to take general long-term investment positions right now in the US stock market. Yes, there are pockets of value in several sectors of the market and I do believe that many sectors can do well in the coming years even if the stock market does not do great, but this is a big warning sign for caution when it comes to the US stock market as a whole. In the long run valuations do matter.
This isn’t the only valuation metric saying that things are very overvalued. The same is the case with Warren Buffett’s favorite. Business Insider reports this favorite indicator “takes the combined market capitalization of all publicly traded stocks in the US, and divides it by quarterly gross domestic product. Investors use it to gauge the stock market’s valuation relative to the size of the economy.”
That stock market to GDP reading is now at 195%, above its level of 2000 too.
We also are getting a big warning sign as speculative pockets of the financial markets appear to be get exhausting, such as Bitcoin. I talked about that in my early morning post you can find here.
-Mike
