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Portfolio > Economy & Markets

Are U.S. Stocks Overvalued?

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The year isn’t even half over, and the S&P 500 has already advanced almost 18% year-to-date. Plus, the value of the S&P 500 has jumped more than 5% during the first two months of the second quarter.

Globally, U.S. stocks are outperforming most developed and emerging-market countries.

Have stock values become overstretched?

“The forward 12-month P/E ratio for the S&P 500 now stands at 14.4, based on [May 16's] closing price (1650.47) and forward 12-month EPS estimate ($114.94),” Factset wrote earlier this month. “This is the highest forward 12-month P/E ratio logged by the S&P 500 in more than three years (April 2010). Given the high values driving the P in the P/E ratio, how does this 14.4 P/E ratio compare to historical averages? Is the index now overvalued?”

On the one hand, the index is now trading above both the 5-year (12.9) and 10-year average P/E ratios, the research firm points out. On the other hand, it is still trading below the 15-year average P/E ratio (16.5), and is not close to the peak P/E ratio of 25 recorded in the late 1990’s and early 2000’s.

The PE10 (also known as the Shiller P/E ratio) is another measure of valuations.

Currently, the S&P 500’s PE10 is at 24.8, which puts it above its historical median of 15.89. While that may seem elevated, it’s still below its 1999 peak of 44.20.

The PE10 is calculated by accounting for yearly earnings of the S&P 500 for each of the past 10 years and adjusting them for inflation using the Consumer Price Index, or CPI.

Since the start of 2013, four industry sectors have topped the S&P’s performance: consumer discretionary (XLY), consumer staples (XLP), healthcare (XLV) and financials (XLF), as measured by their respective Select Sector SPDR ETFs.

The S&P 500 (IVV), tracked by the iShares Core S&P 500 ETF, is up more than 115% since bottoming in March 2009.  

Renowned value investor Warren Buffett still favors stocks over other assets, including bonds. In May, Buffett told CNBC that bonds are a “terrible” investment right now and that owners of long-term bonds may experience large losses once a cycle of higher interest rates kicks into high gear.

Buffett holds stakes in more than 80 companies, including blue chips like Coca-Cola (KO) and Wells Fargo (WFC), via his holding company, Berkshire Hathaway (BRK-A, BRK-B). 

Although the broader stock market may ignore valuations, the first sign of any significant mean reversion will be reflected in a technical break below key price levels.

Remember: valuations are important, but prices are a leading indicator.  


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