How rich are current stock valuations? By whatever metric you use, very rich.
In a report, Ned Davis Research called the S&P 500’s lofty elevation “ugly” and noted that the index is at a point reminiscent of bubbles, such as the one that popped in 2008.
“No matter how one slices it, stocks are expensive based on price/earnings ratios,” wrote Ed Clissold, Davis’ chief U.S. strategist, and London Stockton, a research analyst at the firm.
The report ran through different measurements to demonstrate the precipitously high level that stocks occupy. Only a few other instances, such as during the dot-com bubble, the housing bust and the pandemic shutdown (when earnings skidded faster than stock prices) were higher, it indicated. Indeed, the S&P 500 P/E briefly hit 131 in March 2009 (its low was 5.3 in 1949).
According to the Davis study, the S&P 500 forward P/E of 21.6, as of August, is among the top 9% of all monthly measurements since 1983. Clissold and Stockton acknowledged that forward P/Es are influenced by analysts’ “rosy forecasts,” which “don’t always capture investors’ expectations.” So the report looked at the index’s P/E using operating earnings, namely those that exclude what analysts deem “extraordinary items.” Result: a P/E of 25.7, even higher than the forward multiple.
Then the study looked at GAAP earnings, which include the extraordinary items and also depreciation, interest and taxes. Upshot: a multiple only slightly less than the operating earnings’ version.
Next, the report turned to taking a P/E using the median ratio, smack in the middle of the S&P 500, which was 26.8.
Another investor agreed with the Davis conclusions, but added that a crash is not likely.
If stock prices fall from their towering perches, it likely will not happen in a sudden plunge, predicts Don Townswick, managing director of equities at asset manager Conning. “This is a balloon, not a bubble,” he says in an interview. “It will deflate, not pop.”
Some high P/Es are justified, he says. But as a whole, the current environment is altered due to anomalies of the market, such as the bifurcation between the top seven mega-cap tech stocks in the S&P 500 and the others: 35 times forward earnings versus 18. And 18, he notes, is still several percentage points above the index’s historical average.
Others are more bearish. “This is the most vulnerable market there has ever been,” said , in a recent podcast.
He has a long record of spotting doomed investment frenzies—Japan’s market surge in the late 1980s, the dot-com craze of 1998 to 2001 and the housing mania that followed a few years later. High valuations are routinely followed by market slumps, he said.
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Tags: bubble, Don Townswick, Ed Clissold, Jeremy Grantham, Ned Davis Research, P/E, valuations