Wall Street strategists demanded relatively modest gains for U.S. stocks in 2020. Concerns about stock market valuations have often been cited as a reason why investors should weaken expectations about stock returns in the coming quarters.
In fact, stocks are overvalued according to the common price-earnings ratio (P / E), which compares the price of a stock to one year earnings per share compared to the recent past. The S&P 500 index
according to FactSet, trades 18.6 times the forward profit above the average rate of 16.7 in the past five years and 14.9 in the past ten years.
Other, less questioned methods of valuing the stock market paint an even sharper picture.
The Ned Davis Research chart above shows that the price in relation to sales of the S&P 500 is at a record high and "far above what it had at those highs in 2000 or 2007," Ned Davis wrote in a message from Wednesday to customers.
Other indicators, such as the medium price-performance ratio, which excludes the distorted effects of very profitable and very unprofitable companies, show that the S&P 500 has been overvalued by almost 30% since 1964, compared to the typical valuation level.
"But the S&P 500 could exaggerate profits due to buybacks and other financial techniques," Davis wrote, as company buybacks reduce share circulation and increase earnings per share, even if overall profits have not increased. A look at the ratio of market valuations to total profits therefore suggests that the P / E ratio is about 80% above the long-term norm, Davis wrote.
A disadvantage of these analyzes is that they do not take the effects of interest rates into account. The average effective interest rate for Fed funds since 1964 is 5.2%, compared to 1.6% today, and one could expect equity valuations to be significantly higher when fixed income is so low-yielding.
Andrew Slimmon, senior portfolio manager at Morgan Stanley Investment Management, told MarketWatch in December that it was important to take interest rates into account when valuing stocks. The average dividend yield for S&P 500 shares is 2% above the 10-year US Treasury statement, according to FactSet data
Yield 1.87%. Typically, the S&P 500's dividend yield is 20% lower than the 10-year yield, suggesting that the stock market has more leeway in relation to interest rates.