Daily Spotlight

Stocks Pushing Value Limits

Stock prices, as expressed by the S&P 500, are near all-time highs and, on depressed earnings, are well above fair value, which our model pegs at closer to 3700 due to pandemic-weakened EPS in 2020. Our stock-market valuation model takes into account factors such as stock prices, five-year normalized earnings (three historical years, two forward-looking), GDP, inflation, and T-bond and T-bill yields. We note that stocks rarely trade right at fair value. Since 1960, on average, the index has traded at a tight 2% above fair value, but the standard deviation to the mean is 16%. As such, we normally expect the S&P 500 to trade between 14% undervalued and 18% overvalued. At current prices, the stock market is almost 30% above fair value, implying that investors are quite optimistic about equities. Though we are still bullish on the economy and earnings, we'd feel better about the longer-term outlook for stocks if valuations were not so stretched. Several factors could improve valuations: a pullback in stock prices, perhaps related to fears of inflation; lower bond yields; or better earnings (which we do expect in upcoming quarters). ...  at a tight 2% above fair value, but the standard deviation to the mean is 16%. As such, we normally expect the S&P 500 to trade between 14% undervalued and 18% overvalued. At current prices, the stock market is almost 30% above fair value, implying that investors are quite optimistic about equities. Though we are still bullish on the economy and earnings, we'd feel better about the longer-term outlook for stocks if valuations were not so stretched. Several factors could improve valuations: a pullback in stock prices, perhaps related to fears of inflation; lower bond yields; or better earnings (which we do expect in upcoming quarters).   more

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