Tuesday, May 28, 2024
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Is the US Stock Market Overvalued? Four Value Indicator Checks.

The US stock market value has changed a lot over the last 2 years. The S&P500 fell sharply during the early phases of Covid, then went on a growth spurt to new highs and in 2022 has dropped back a little. The question many of us are asking is, “Is the stock market overvalued or undervalued?”

An extremely complicated calculation this might be, especially as we can’t predict the future. However, there are a few indicators that we can look at.

First up let’s look at the Buffett Indicator.

The Buffett Indicator

The Buffett Indicator was a metric created and put forward by the famous investor Warren Buffett. He called it “probably the best single measure of where valuations stand at any given moment”.

If we take a look at the website currentmarketvaluation.com it states that the ‘The Buffett Indicator is the ratio of the total United States stock market valuation to GDP’.

Another way to say this is the total value of US stocks divided by the size of the US economy. For this he uses the Wilshire 5000 Index.

Buffett Indicator: Composite Market Value (source: currentmarketvaluation.com)

If we scroll down on the page we can see both a figure and the current values and analysis. According to currentmarketvaluation.com the Buffett indicator is “currently 33% (or about 0.9 standard deviations) above the historical average, suggesting that the market is Fairly Valued.

Even though the exponential trendline is 127%, the 169% now sits within 1 standard deviation and is fairly valued.

Stock Market Price/Earnings Ratio

The P/E ratio is a common metric used to value stocks and we can look at the whole market with this indicator too.  We are looking to see whether it is significantly higher or lower than it’s average.

It’s worth checking out a few sites for your ratios as data and calculations can vary between them.

If we look at multpl.com we can see that the current P/E ratio is 19.33 which is above the mean of 15.97 and median of 14.89 , suggesting that the market is overvalued.

Cyclically Adjusted Price Earnings (CAPE) ratio

If we also look at currentmarketvaluation.com again we can see that they have a few different figures. It suggests that using the Cyclically Adjusted Price Earnings (CAPE) ratio is more useful. “The indicator currently shows the current S&P500 10 year P/E ratio is 28.7. This is 43% above the modern-era market average of 19.6, putting the current P/E 1.1 standard deviations above the modern-era average.” This also suggests that the market is overvalued.

Tobin’s Q Ratio

This ratio is found by dividing the market value by the replacement value. Again opinion differs on how effective this measure is, but the idea is that a value over 1 suggests that the market is overvalued and under 1 suggests it is undervalued.

Tobin's Q Ratio Y Charts

One site we can see this metric is ycharts.com. The last measure in March for Q1 2022 was of 1.598, showing at this point the market was overvalued. it is also important to look at historical means. The mean average in the 10 year period from 2010 to 2019 inclusive was approximately 1.35. So again the current value of nearly 1.6 is well above this.

Mean Reversion

This method of valuation is quite basic. It assumes that although stock prices can be volatile in the short term, they will generally revert back to a mean average in the long run.

Mean Reversion S&P500

Currentmarketvaluation.com shows us that the S&P500 is currently 31% above the modern-era trendline. This is suggesting that the market is currently overvalued.

Further Metrics

On the site currentmarketvaluation.com there are a few other valuation metrics to look at including Yield Curve Reversion and Interest Rates. Morningstar also has a Market Fair Value ratio. You could also look into other ratios such as the market price to sales ratio.

In Summary

All indicators have their flaws, and the stock market is extremely hard to predict. Timing investing in the markets is extremely complicated. Using the indicators in this post suggest that the market is overvalued, but any indicator predicting the future of the stock market has to be taken lightly and we certainly shouldn’t take this as a reason to sell all of our stock portfolio.

We don’t provide financial advice, so please do your own research before using tools discussed on this channel.