Many in the investment community think the stock market appears stretched over its skis.
The S&P 500 has soared 25% over the past 12 months, compared with an annual average of 9% over the past 50 years.
The index has hit records in 38 sessions this year, most recently on July 16. And that has pushed valuations well above historical norms.
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As of Aug. 16, the forward price-earnings multiple for the S&P 500 was 21, compared with the five-year average of 19.4 and the 10-year average of 17.9.
That's got a lot of people nervous, including money-management colossus Vanguard ($9.3 trillion of assets under management).
“We have been cautioning investors for some time that U.S. stocks — and growth stocks, in particular — are richly priced,” Joe Davis, the firm’s global chief economist, wrote in a commentary.
“Indeed, the cyclically adjusted price-to-earnings ratio of the stock market stands at about 32% above our estimate of its fair value.”
The CAPE multiple, created by the Nobel laureate economist Robert Shiller, includes average earnings for 10 years rather than the single year used in standard PE multiples. The idea is to diminish the impact of an outlying year of earnings.
The CAPE multiple stood at 36.23 on Aug. 27, a level surpassed since the 19th century only during the dot-com bubble of the late 1990s and the post-pandemic surge in 2021.
Putting Vanguard’s view in context
To be sure, the danger isn’t all-encompassing, Davis said. “While growth stocks and the broad stock market appear to be overvalued, small-capitalization, value and non-U.S. stocks appear to be fairly valued,” he wrote.
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Market mania over artificial intelligence has been a major factor boosting stocks over the past year. That enthusiasm is overdone, Davis said:
“It’s improbable at best that the rapid economic and earnings growth [resulting from AI] would correct the current excess valuation of the U.S. stock market.”
Profits would have to really take off to pull the market out of its overvalued status, he said.
Assuming a three-year horizon for a return to fair value, profits would have to soar 40% per year to unwind the market’s excess.
“This is double the annualized rate of the 1920s when electricity lit up the nation — not to mention economic output and corporate income statements,” Davis said.
Goldman Sachs issues short-term stocks outlook
On the other hand, at least in the short term, Goldman Sachs is bullish on stocks.
Corporate stock buybacks and trades made according to computer algorithms will help fuel the move, said Scott Rubner, managing director for global markets and tactical specialist at Goldman.
“We estimate $17 billion of unemotional demand between robots and corporates every day this week,” he wrote in a commentary on Monday cited by Bloomberg. “There is a very positive three-week equity trading window until Sept. 16.”
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Meanwhile, “sellers are out of ammo,” Rubner said. Presumably, he means that with stock bears incurring so many losses shorting stocks over the past year, they’re reluctant to sell more shares short.
“Everyone is going back to the pool,” he wrote. Algorithmic traders have overshot their downside exposure to stocks.
Goldman has indicated that the Federal Reserve’s signal that it will cut rates next month can temporarily prop up stocks.
“The pain trade for equities is higher, and the bar for being bearish at the beach into a Labor Day barbecue party is high,” Rubner wrote last week, continuing his summer-fun metaphor.
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