When Someone Says the S&P is Overvalued
If you consume any financial news, you will inevitably come across a prognosticator who believes the market is overvalued.
As Nick Murray points out in his February note, “The Market’s Too High.” Where Have I Heard That Before? When you read or hear that statement, you should have two questions:
How are you defining overvaluation?
Have you found valuation to be an effective market timing tool?
Regardless of how they answer the first question, the answer to number two is probably “no.” Valuation is generally a terrible market timing tool. For example, here is a chart looking at the forward price-to-earnings (P/E) ratio of the S&P 500 (while also highlighting the status of 5 other common valuation measures).
(Source: JP Morgan Guide to the Markets)
At first glance it looks like we are approximately 1 standard deviation above the market’s 30-year average Forward P/E (which seems like a bad thing), but this number doesn’t tell us much about what will happen in the near term.
Buying into the S&P when it was “undervalued” in 2007 didn’t work out in the short-term and selling the S&P when it was “overvalued” in 2020 didn’t work out either. More importantly, when you take a longer-term perspective (which is the only perspective that matters for equity investors) the numbers tend to even themselves out.
For example, if you bought into the S&P 500 on March 1, 2000, a few weeks before the dot com bubble exploded and the S&P 500 went down 49.10% (which was subsequently followed by a decline of 56.8% in the Great Recession, a 19.4% decline in 2011, a 19.8% decline in 2018, a 33.9% decline in 2020, and a 25.4% decline in 2022) you still managed to achieve annualized returns of 7.114% through January of 2024. A cumulative return, with dividends reinvested, of 414.43%. Certainly, below the market’s long-term average, but, as Mr. Murray points out in his article, “I suspect that there are any number of people who’ve been chasing their tails trying to time the market since 2000, who might be very glad to have gotten that return.” I tend to agree.
(Source: DQYDJ – S&P 500 Return Calculator)
As always, if you have questions about this or anything else, we are always here to help.