How overvalued is the S&P 500?
March 30, 2021
As a portfolio manager and wealth planner, I believe investing in stocks has historically been an effective way to grow your portfolio over the very long term. But, investors might want to be watching the “12 month trailing Price to Earnings Ratio” (a commonly used metric for estimating average U.S. stock valuations as compared to their earnings). This metric may be indicating that investors might want to be aware of their risk tolerance, and amount of stocks held in their portfolio. Investors should also measure their expectations of continued stock market growth vs. the potential for a sizeable stock market downturn.
Based on this commonly used valuation metric for stocks, the S&P 500 US Stock market index is approximately 150% overvalued based on historical standards. This a higher over-valuation than just prior to the Stock Market Crash of 2000-2002 (“The Tech Bust”), and just prior to the “Great Financial Crisis” recession of 2007.
(As of March 30, 2021 the 12 Month Trailing PE Ratio is 40. With the approximate historical average PE ratio at “16”, current ratio levels put the S&P 500 Index in an overvalued state by approximately 175%.. Historical references of the 12 month trailing PE ratio can be found at: https://www.multpl.com/s-p-500-pe-ratio, and current publication of the trailing 12 month Price to Earnings can be found on the Wall Street Journal website at https://www.wsj.com/market-data/stocks/peyields.
I am not a “perma-bear” (an investor or portfolio manager who is always thinking that the stock market will meet its demise at any moment). But there are times as history has shown that at the end of economic super cycles where investors should be highly cautious and know their investment options to help preserve their portfolios, and possibly position their portfolio to potentially take advantage of investing opportunities which may arise in times of stock market and economic uncertainty and volatility.
Know history and your investing options:
Due to the overvalued state of the overall U.S. stock market, along with the historically large decline in economic growth due to Covid-19 induced economic damage…. stock market investment risk may be considered much higher than average today.
During each of the two last recessions (2001 and 2007-09) where stocks and real estate assets were considered highly overvalued, the S&P 500 dropped approximately 50% to 55%.
The average recovery time needed to gain back pre-crash value of stock market losses from the “Technology Bust” recession was 8 years, and the average recovery time for recovery from the Great Financial Crisis recession was 7 years.
I suggest anyone who owns a stock portfolio of any size to evaluate their time horizon for their investments and understand their risk exposure. In addition, take a look at historical stock market performance of the last two recession periods. (Stock Market Crash of 2000-2002 “The Tech Bust”), and the “Great Financial Crisis” recession of 2007-2009). http://www.nbcnews.com/id/37740147/ns/business-stocks_and_economy/t/historic-bear-markets/#.XRz7hehKiUl
Periods of “irrational exuberance” of highly overvalued stock markets may continue for some time, but I feel the current highly overvalued state of the markets today has been going on for approximately 3 years now. I recommend investors ask themselves the following questions…. How much time can I wait to recover if overvalued markets decline substantially? If so, what can I do to tactically preserve my investments?
In the future there will most likely be many new investment opportunities, but warning signs are once again flashing.
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Michael Raymond Bacci, CFP
History and past performance are not a guarantee of future performance. Information contained in this commentary is not the opinion of LPL Financial or it’s affiliated companies. Any information contained within this commentary is not a solicitation to buy or sell securities or advice to buy or sell securities.
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.