Are U.S. stock valuations expensive?


It’s not surprising that some investors are wondering if U.S. stocks are overvalued with the S&P 500 continuing to hit new all-time highs. We have certainly come a long way since the financial crisis with the index nearly tripling from the March 2009 low.

With the bull market celebrating its five-year anniversary, now may be a good time to step back and take a look at historical price-to-earnings ratios for U.S. stocks.

Forward 12 month P/E ratios are still well below the peak of the dot-com boom, and below the 15-year average.

The current bull market is also different from the late 1990s boom because it’s more broad-based and less focused on the tech sector.

Of course, the bull market punctuated by the tech bubble was one of the longest and most exuberant in U.S. history. Therefore, it may be helpful to widen the timeframe and delve deeper into history.

Many investors track the cyclically adjusted price-to-earnings ratio (CAPE) developed by economist Robert Shiller. The valuation measure incorporates trailing 10-year P/E ratios adjusted for inflation.

The CAPE ratio for the S&P 500 is currently about 25.2, its highest level since 2007. The ratio notched an all-time high of about 43.8 during the dot-com bubble, while the long-term CAPE average is about 16.5.

So the CAPE ratio is above its long-term historical average, which has caused some analysts to worry that U.S. stock are overvalued.

Yet stocks can remain overvalued or undervalued for long periods of time. In other words, investors shouldn’t rely on any one metric, such as CAPE, to tell them whether it’s safe to be in stocks. That’s why a portfolio diversified across asset classes could make sense for long-term investors.

In November, Shiller told The Wall Street Journal that the CAPE ratio, while high, wasn’t in the danger zone. “It could be a bubble, but it might not be…it will take a little time to tell,” he said in the WSJ article.

“Investors are always looking for clues to the market’s future. It’s only natural to want to limit your downside while maximizing potential returns, but trying to time the market often ends badly — you’ll either miss out on a roaring bull market or dive after plunging stocks into deep losses,” reports Alex Planes at the Motley Fool. “Shiller himself has cautioned against using the CAPE to time the market, as he views it more as a guide to future returns than an indicator of imminent crashes.”

Photo Credit: brian glanz

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Past performance is no guarantee of future results.