Is the Stock Market Overvalued?

ZeroHedge wrote recently, “Looking back through more than a century of financial data, the long-term average P/E ratio for the S&P 500 has been about 15.

As of February 23, the P/E ratio for the S&P 500 stock index reached 26.5.

That’s high – more than 75% higher than the long-term average.

More importantly, since the 1870s, there have been a total of THREE periods in which the average stock P/E ratio was above 26.5.

 

1. The first time was around the Panic of 1893.
2. The second was around the 2000 dot-com crash.
3. And the third was around the 2008 financial collapse.

 

So, to answer the question “Is the Stock Market Overvalued?” I would answer a resounding: YES, the market is overvalued!

Some say that the big tax cut for American Corporations proposed by President Trump would have a big effect on earnings. Then the stock market would no longer be overvalued.

Don’t believe it. According to an analysis from Ned Davis Research, a cut in the effective corporate tax rate to 15% would add an estimated $12.84 to the S&P 500’s earnings per share. That would reduce the market’s P/E ratio from its current 22.9 to 20.2, when calculated based on trailing 12 months as-reported earnings. That would still be far higher than the 145-year average of 15.6 (according to data from Yale University’s Robert Shiller).

So…Is the Stock Market Overvalued?

Here’s another way to measure whether the stock market is overvalued. CNBC says, “Right now, the total market cap of the Wilshire 5000 index as a percentage of U.S. gross domestic product is about 120 percent, far above the 45-year average of 75 percent. To some, this indicates that stocks are priced too richly, and hence may not be a good buy at these levels.”

“The issue with that is even if we were to see exceptionally fast growth over the course of the next eight years to the tune of 8 percent nominal GDP growth per year, we would still be at 80 percent market cap to GDP, which still puts us above that long-term average,” Mark Tepper, president of Strategic Wealth Partners, said Friday on CNBC’s “Trading Nation.”

Is the Stock Market Overvalued? Yes but it is different this time, say some analysts. The world is falling apart. The Euro is likely to fall apart with Norway and France voting to leave the European Union like Britain, and all that Euro money will flow to the U.S. strengthening the dollar and buying stocks. Then there is Trump bulling the economy. The only safe place for your investments is the U.S. We could be looking at 23,000 or even 30,000 on the Dow.

Is there any technical evidence that the market is ready to fall? I would say yes. Look at the chart of the Dow Jones Industrials courtesy of StockCharts.com, Inc.

Look how at “A” the PPO (percentage price oscillator) and the Dow moved to new highs, then months later at “B” the Dow hit new highs but the PPO didn’t.

To me the divergence signals trouble ahead…