This article is written exclusively for Investing.com
Stocks around the world have been going to the races since March. Call it a liquidity-fueled, momentum-driven rally that has sent companies with the fastest earnings growth rates to some of the highest valuations in decades. Even the country has seen its PE ratio rise to well above 20, based on 2021 earnings expectations.
Blame it on the ultra-low rates triggered by aggressive monetary policies in the face of the coronavirus pandemic . It has made investors grapple with new ways to value stocks and the overall market. But just because those creative metrics have helped push the market higher doesn't change the reality of the situation that stocks are historically overvalued.
S&P 500 To US GDP
Remember that the S&P 500 trades at over 150% of the total GDP of the US economy; it is the highest level ever. And yes, while the US economy's GDP will rebound sharply in the coming years, hitting above the 2019 peaks of nearly $ 20 trillion. It will likely take some time to rise to over $ 30 trillion, the current market cap of the entire S&P 500.
Get Creative
Of course, if we get really creative, you could even argue that the S&P 500 must be more than double the current 3700 level in this low-fare world. Take, for example, the S & P's dividend yield of about 1.5%, which is 60 basis points higher than the Treasury's rate.
Historically, the dividend yield of the S&P 500 has traded at a discount to the 10-year Treasury. With that logic, the S&P 500 would have to climb an awful lot to get its dividend yield at or below 90 basis points. Over the last twelve months, the S&P 500 has a cash dividend of about $ 58.85, which would mean that the S&P 500 should rise to about 6,500.
Other Side of the Same Coin
Using a profit yield method for the S&P 500, the index would be seen trading at 4.5% based on profit estimates of about $ 165 a share for the S&P 500 in 2021. It values ??the S&P 500 at about 22.5 times the earnings expectations for 2021. But if we use that earnings yield and compare it to the 10-year Treasury, we see that the spread is around 3.6%. That spread happens to be right in line with where the S&P 500 traded in January, before the coronavirus pandemic.
But ironically, despite trading at the same valuation compared to the 10-year treasury rate based on a profit yield. Based on the PE ratio, the S&P 500 is much more expensive than it was in January, when it traded at just 19 times its expected one-year gain.
The Inverse of 1999
It creates an interesting and complex problem. If the profit multiple of 22 on a forward basis is very expensive. Does it make the returns on low interest-adjusted earnings 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?
Looking at it another way, the current S&P 500 earnings yield since 1985 has only been equal to or below the current level in any other period. It would only make sense that that period came in 1999 and 2000.
Ironically or not, this was another time when investors tried to understand the extreme overvaluation in the stock market. The rates were of course higher during that period. Still, the economy was booming, delivering colossal growth rates, again justifying the high PE ratios, which just happens to be the reverse of earnings returns.
Call it a coincidence if you like. But the similarities are surprising. The same super high ratings and a story that is the exact opposite. Using the reverse of the same valuation measure, with today's low-growth world versus the immense growth, high-interest world of 1999.
Whether it's a high PE ratio or a low profit yield, it may not matter as it is the same but said differently.
