Are Equities Overvalued?

March 27, 2015

2 minute read

Are Equities Overvalued?

by Ryan Lewenza, CFA, CMT, Private Client Strategist, Raymond James

• This month marks the sixth anniversary of the current bull market, with the S&P 500 Index (S&P 500) up an incredible 210% over the last 72 months. Given the strong gains in this current cycle (not to mention the long duration), some investors are growing increasingly concerned over equity market valuations.

• Currently, the S&P 500 trades at 18.3x trailing earnings, which is an 11% premium to its long-term average of 16.5x dating back to 1954. We typically define an asset/index as being “overvalued” when it trades 1 standard deviation (SD) above its long-term average. Presently, +1 SD on the S&P 500 trailing P/E equates to 21.3x which is well above the current 18.3x level.

• Looking at the S&P/TSX Composite (S&P/TSX) it is currently trading at 19.8x trailing earnings which is a 4% premium to its average since 1994. On an earnings basis, valuations are slightly above their long-term averages.

• However, other more arcane valuation metrics are painting a more worrisome picture. For example, the Shiller cyclically-adjusted P/E (CAPE), which divides the S&P 500 price by the average earnings for the index over the last 10 years, currently stands a lofty 27.5x which is roughly 2 standard deviations above its long-term average of 16.5x. Additionally, the “Buffet Indicator” which compares total US equity market capitalization to GDP is also at an elevated level (see Chart of the Week).

• We agree with the “bears” that valuations have significantly increased and that equities are “overvalued.” Despite this there are a number of factors including low interest rates and the likelihood that we are in a new secular bull market that could lead to continued equity gains in 2015, and over the next decade.