Breaking News
0
Ad-Free Version. Upgrade your Investing.com experience. Save up to 40% More details

How To Make Sense Of S&P Stock Valuations

By Michael KramerStock MarketsDec 11, 2020 05:59AM ET
www.investing.com/analysis/how-to-make-sense-of-sp-stock-valuations-200547578
How To Make Sense Of S&P Stock Valuations
By Michael Kramer   |  Dec 11, 2020 05:59AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 

This article was written exclusively for Investing.com

Stocks around the globe have been off to the races since March. Call it a liquidity fed, momentum-driven rally that has sent companies with the fastest earnings growth rates to some of the highest valuations in decades. Even the S&P 500 has seen its PE ratio soar to well over 20, based on 2021 earnings estimates.

Blame it on the ultra-low rates brought on by aggressive monetary policy in the face of the coronavirus pandemic. It has left investors scrambling for new ways to value stocks and the overall market. But just because those creative metrics have helped push the market higher, it doesn't change the situation's reality, that stocks are historically overvalued.

S&P 500 To US GDP 

Consider that the S&P 500 is trading at well over 150% of the US economy's total GDP; it is the highest level ever. And yes, while the US economy's GDP will rebound sharply over the next few years, moving above the 2019 highs of nearly $20 trillion. It is likely to take some time before it climbs to over $30 trillion, which is the market capitalization of the entire S&P 500 today.   

S&P 500 Vs US GDP
S&P 500 Vs US GDP

Getting Creative 

Sure, if we get really creative, one could even argue the S&P 500 should be more than double its current level of 3,700 in this low rate world. Take, for example, the S&P's dividend yield of around 1.5%, which is 60 basis points higher than the 10-year Treasury rate.

Historically, the dividend yield of the S&P 500 has traded at a discount to the 10-year Treasury. Using that logic, the S&P 500 would have to rise an awful lot to get its dividend yield at or below 90 basis points. Over the trailing twelve months, the S&P 500 has a cash dividend of about $58.85, which would mean the S&P 500 would need to rise to around 6,500. 

S&P 500 Yield Vs 10-year Yield
S&P 500 Yield Vs 10-year Yield

Different Side Of The Same Coin

Using an earnings yield method for the S&P 500, one would find the index trades at 4.5% based on earnings estimates of around $165 per share for the S&P 500 in 2021. It values the S&P 500 at roughly 22.5 times those 2021 earnings estimates. But using that earnings yield and comparing it to the 10-Year Treasury rate, we find that the spread is around 3.6%. That spread happens to be precisely in line with where the S&P 500 was trading in January, before the coronavirus pandemic.

S&P Yield/10-year Yield
S&P Yield/10-year Yield

But ironically, despite trading at the same valuation compared to the 10-year treasury rate on an earnings yield basis, on a PE ratio basis, the S&P 500 is much more expensive than in January, when it was trading at just 19 times one-year forward earnings estimates. 

The Inverse of 1999

It creates an interesting and complex problem. If the earnings multiple of 22 on a forward basis is very expensive. Does it make the low-interest rate adjusted earnings yield correct or sustainable? Has the market come up with a new way to value the S&P 500 and stocks, in general, to justify its incredible push higher. 

 

S&P Yield
S&P Yield

 

When looking at it yet another way, today's S&P 500 earnings yield has only been equal to or lower than its current level in one other period since 1985. Of course, it would only make sense that period came in 1999 and 2000. 

Ironically or not, this was another period where investors were trying to make sense of the extreme overvaluations in the equity market. Of course, rates were higher during that period. Still, the economy was booming and delivering colossal growth rates, again justifying the high PE ratios, which happens to be the inverse of the earnings yield.  

Call it a coincidence if you'd like. But the similarities are startling. The same super-high valuations and a narrative that is precisely the opposite. Using the inverse of the same valuation metric, with the no-growth, low rate world of today, versus the immense growth, high rate world of 1999. 

Whether it be a high PE ratio or low earnings yield, it may not matter because it is the same thing, just said a different way. 

How To Make Sense Of S&P Stock Valuations
 

Related Articles

How To Make Sense Of S&P Stock Valuations

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (4)
Dee Mehta
DMFINANCE Dec 12, 2020 7:13AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Great work
Russell Lemos
RSL1971 Dec 11, 2020 9:46AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Gr8 analysis with relevant data points.
Alex Giuffrida
Alex Giuffrida Dec 11, 2020 8:37AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
👍🏻
clayton park
clayton park Dec 11, 2020 6:19AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
good write up Mike! always appreciate your insights
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.
Continue with Google
or
Sign up with Email