Is the stock market overvalued?
Filed under: Investing, Earnings
Are stocks overvalued? Marketwatch editor Mark Hulbert, founder of Hulbert Financial Digest, offers two barometers which investors should look at carefully. Hulbert's first measure is the trailing, 12-month P/E barometer; using that metric, the P/E ratio of the S&P 500 is currently greater than 1,800-to-1.
You read correctly: it's greater than 1800-to-1. And, Hulbert adds, it gets even more jaw-dropping, due to the fact that trailing, 12-month earnings for the S&P 500 are likely to drop below zero later in 2009.
Of course, as the P/E's denominator gets smaller and smaller, the value of the ratio gets larger and larger, as Hulbert points out. That may compel some investors to dismiss the P/E ratio, and it's a valid critique.
Recognizes that criticism, Hulbert offers a modified P/E ratio that Yale University Economics Professor Robert Shiller (of Case-Shiller Home Price Index fame) has calculated and analyzed for decades. One advantage of Shiller's modified P/E ratio? It overcomes problems that stem from artificially depressed earnings at bear market lows: the denominator in this metric is average, inflation-adjusted earnings over the trailing 10 years.
Using Shiller's modified P/E ratio metric, the P/E for the S&P 500 is about 16.4. The 140-year average: 16.3. The 140-year median: 15.7.
With a modified P/E ratio of 16.4, one could make a strong case that the market is fairly valued. Hulbert takes the stance that, even dismissing the trailing, 12-month P/E barometer, the market is not undervalued: it's hard to argue that stocks are cheap now, Hulbert concluded.
Market Analysis: Investors should keep in mind that markets historically overshoot and undershoot both the P/E average and median. They're sort of like your highway speed, without using cruise control: the speed limit may be 60 miles per hour, but they'll be extensive periods of travel when you're doing more than 60 and periods when you're doing less.
In addition, the economic cycle can further complicate evaluations of the market's P/E. Institutional investors tend to bid-up the market, even well above the average P/E - and often for long periods of time - if they believe that better economic times are ahead; bid-down, if they believe economic conditions are worsening.
The above underscores some of the limitations of using only market P/E ratios to determine whether the market is overvalued/undervalued, i.e. whether it's a good time to buy stocks, and that's why I use a cross-methodological approach, which incorporates other technical indicators, stock and economic fundamentals, and other metrics.
One technical indicator I follow very closely: the 200-day moving average – the toughest average to break in trading. And right now the S&P 500 at 881.03 has fallen below the 200-day MA of 884.99. If the S&P 500 closes below that average for two more days - or three days in a row - that would be bearish for the market. If the aforementioned occurred, I'd need to see a 3-day close above the 200-day MA, with strength in other technical and fundamental indicators, before I'd turn bullish on the market again.
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Financial Editor Joseph Lazzaro is based in New York.
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Reader Comments (Page 1 of 4)
7-08-2009 @ 11:28AM
STATEMAN26 said...
You will know the stock market is overvalued when interest rates move up and all the snake oil salesmen in financial services start piling out of the stock market faster than rats leaving a sinking ship. For that reason, it is best to ignore any recommendation you hear on Bloomberg, Faux News, and CNBC to climb aboard that sinking ship now.
Once there's blood in the street; you hear the roar of the cannon, and interest rates are above 15%, then you can start investing in the stock market by dollar cost averaging, but not until then.
The worst is yet to come and Obama and Co. are missing that boat too.
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7-09-2009 @ 12:36AM
JP said...
We're being set up for a new world order. The Gov. wants to distress this nation so they can declare martial law. That will give them control over everything. You can bet the U.N. is involved in this also. Obama seems to be way to relaxed. He sure doesn't seem to to concerned about us. All these trips to these world leaders, who knows what else they're talking about. Bill Clinton said at one time that the world population needs to be decreased to 1 billion.
http://New-World-Order.itrustgodonly.com/ -
http://death-camps.itrustgodonly.com/The-Obama-Deception/
7-08-2009 @ 11:35AM
catherine said...
it's been overvalued for years, it was just a matter of time before something punctured the balloon, but the people are the ones who are paying for it
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7-08-2009 @ 11:39AM
ann said...
Obama says it is and I think he would like to see the stock market sink quite a bit before he'll be happy that the wealth is finially spread around to his liking.
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7-08-2009 @ 11:50AM
Brett said...
Ann, maybe you can explain to the people in the reality based community how having wealth disappear, by the value of our public corporations shrinking from lower stock prices, could possibly create any wealth to spread around?
7-08-2009 @ 12:38PM
Mike McKibben said...
Ann, President Obama didn't start this slide, it started about 10 years ago when the then Republican lead Congress and President Clinton sold out this countries manufacturing base to China...........under the name of "Free Trade". This it was compounded by then, Sen Phil Graham's (R - Tx retired) Legislation that gave Wall Street the ability to sell unregulated high risk commodities............and gave us ENRON. ENRON was the warning shot fired across our economic bow, but no one heeded the warning. Now, as it were, a few people made a LOT of money, some made good money, and the rest of us.......say 95%, ended up holding the "dead fish" (as Palin would say) or bag. As the Republicans are so fond of saying, "there is a lot of blame to go around", they should know! Please place the blame on the right door stop!
7-08-2009 @ 11:45AM
Tyde said...
Thanks to Obamanomics and the media painting all these lovely pictures of what his policies will do for us the entire market is probably over-inflated by 20% or more.
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7-08-2009 @ 11:52AM
Stan said...
I agree the snake oil market makers are out to get whatever they can from the main street investor. Over time they have learned just how to manipulate the main street investor into buying what they want to sell. Just look at the reports for they last couple of days. Stores came out that the market would adjust up. The premarket SP was higher yestrday morning which encouraged main street investor to buy. Once that happened the wall street pros started to dump. SO NOT BELIEVE ANYTHING THEY HAVE TO SAY. ITS ALL A LIE. THIS MARKET IS TOTALLY OVERPRICED. WE ARE NOW DOUBLE DIPPING. WE COULD EASILY TEST THE LOWS OF THE YEAR OR BELOW.
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7-08-2009 @ 11:53AM
maloo said...
Our country at this time is one third into the greater depression. Obama and Co. have not started with spreading our wealth, only your assets. Next is taxing you to death and then placing our country into Socialism. The bankers are angry about credit card debt and commercial property defaults, they have chosen to close the credit market and allow the Fed to take action against this next debacle yet to unfold. God Bless America, we need to start on Congress and clean the slate.
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7-08-2009 @ 11:53AM
dajt57 said...
yes the market is waaaay overvalued. has been for the last 20 years. the market is not based on reality. a bunch of idiots who think they have to make a lifetime of profits every week.
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7-08-2009 @ 11:59AM
Mark said...
It is because investors do not understand fundamentals that "counselors" and talking heads can get away with pseudo-numeric-speak and not be challenged. The real fundamentals are whether the company makes a quality product and if that product fit into the existing or growing marketplace. Everything else is smoke an mirrors. No ratios, general economic projections or econo-babble will make a dog-stock fly. Pick a company where you believe in it, not because of general economic analyses.
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7-09-2009 @ 7:28PM
LARRY said...
WITH OBAMA IN OFFICE EVERYTHING IS OVER VALUED AND NOT WORTH THE PAPER IT IS WRITTEN ON----------OBAMA IS A DETRIMENT TO SOCIETY---------
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7-08-2009 @ 12:08PM
Ron said...
The public has been way oversold on stock investing for retirement for well over a decade, creating stock prices that are much too high. Fair value for the Dow is probably less than 3,000. This whole departure from demanding a significant portion of the return based on the current dividend, to stock prices based mostly, and often solely, on hoped for greater earnings, higher dividends and price appreciation is just wild speculation, and it's not the general public that's winning at all. The SEC has done a terrible job of regulating the market, allowing all these sophisticated, esoteric trading strategies that benefit the professional quick buck artists to the detriment of the average investor, and the corporations make their executives rich at the expense of their stockholders. In short, it's become a losers game, unless you work on "Wall Street".
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7-08-2009 @ 12:46PM
Tom said...
Not so sure I'd use the term :"overvalued:". 'Overheated' would be a better one. And still smoldering with fumes- from the eight years of abuse.
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7-08-2009 @ 12:25PM
larry said...
obama is travling around the world with his whole family, who is paying this? he is riding on a free dime, while we pay for his exotic vacations.
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7-08-2009 @ 6:35PM
Ron said...
Gee you didn't bitch when Bush was taking 40 days of vacation in Crawford to "fix up the ranch" shortly after being put in office on his first term. You didn't bitch when Bush was the first president to collect a $400,000.00 salary (doubled from what Clinton got). BUsh travelled all over too, but you didn't bitch then. Guess you only bitch when a democrat is involved. Well the republicans screwed things up and as history has shown, it takes a democrat to fix things.
7-08-2009 @ 9:09PM
Forester said...
Ron, I haven't seen anything "fixed" yet. Is this the "Change We Can Believe In"? How's the "Hope and Change" working out for you?
7-08-2009 @ 12:43PM
Mike McKibben said...
Brett, I would like to hear her answer to that too.
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7-08-2009 @ 12:45PM
pat said...
obama is a disaster ...........wake up america
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7-08-2009 @ 12:47PM
Mike McKibben said...
larry, he's going to the G8 conference, and doing our Countries business. (I believe Bush went to a few of them) You don't know who is paying for the cost of his kids any more than I do. Give it a rest!
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