Daily Spotlight

Stock Valuations Still Lofty

Stock prices (as expressed by the S&P 500) are near all-time highs and (on earnings that are still recovering) are well above fair value, which our model pegs at closer to 3,800. Our stock market valuation model takes into account factors such as stock prices, five-year normalized earnings (three historical years, two forward-looking), GDP, inflation, and T-bond and T-bill yields. We note that stocks rarely trade right at fair value. Since 1960, on average, the index has traded at a tight 2% above fair value, but the standard deviation to the mean is 16%. As such, we normally expect the S&P 500 to trade between 14% undervalued and 18% overvalued. At current prices, the stock market is more than 40% above fair value, implying that investors may be overly optimistic about equities in the coming months. Though we are still bullish on the economy, earnings, and continued low interest rates, we'd feel better about the longer-term outlook for stocks if valuations were not so stretched. Several factors could improve valuations: a pullback in stock prices (which occurred in September); lower bond yields; or better earnings, which we are starting to see as 3Q EPS reports are released. ...  fair value, but the standard deviation to the mean is 16%. As such, we normally expect the S&P 500 to trade between 14% undervalued and 18% overvalued. At current prices, the stock market is more than 40% above fair value, implying that investors may be overly optimistic about equities in the coming months. Though we are still bullish on the economy, earnings, and continued low interest rates, we'd feel better about the longer-term outlook for stocks if valuations were not so stretched. Several factors could improve valuations: a pullback in stock prices (which occurred in September); lower bond yields; or better earnings, which we are starting to see as 3Q EPS reports are released.   more

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