Are Stock Markets Over-Valued?

Prices have gotten so high that “finding value in stock markets at present is like looking for the sixpence in a Christmas pudding,” wrote Duncan Lamont, head of research and analytics at Schroder Investment Management. Value is there, “but it’s hard work finding it. Others round the table are likely to end up disappointed.”

This is true globally, and according to Lamont, of five major equity regions, only one “could arguably make a case for being attractively valued,” as seen in the following chart. And this is based on data upto 2017, more current information many suggest it is worse now with indices moving further up.

Lamont’s analysis looks at five major regions — the U.S., the U.K., Europe (excluding the U.K.), Japan and emerging markets — and evaluates them based on five valuation measures: price-to-book, dividend yield, both forward and trailing price-to-earnings ratios, and CAPE, or the cyclically-adjusted price-to-earnings multiple.

Based on these measures, the U.S. stands out as the most expensive of the major market regions, with prices at least 10% above their 15-year average on four of the five valuation metrics. The forward P/E is 19, above the historical average of 15, while the trailing P/E of 24 tops the long-term average of 18. The average U.S. price-to-book ratio is 3.3, compared with the historical average of 2.8.

Perhaps the most ominous reading is the CAPE, which compares the S&P to its average, annual inflation-adjusted earnings over the previous 10 years. At 31, it is above the 15-year average of 25, and nearly twice a long-term average of 16.8 that goes back to 1881. The only other times it has topped 30 occurred in 1929, before the Great Depression, and between 1997 and 2002, during the dot-com bubble.

The fifth metric, dividend yields, shouldn’t offer much comfort to investors. The average comes in at 1.9%, which is essentially even with the long-term average of 2%. Other countries currently boast much higher yields. Australia, for example, has an average yield of 4.2%, according to Bespoke Investment Group.

While the other four regions Lamont studied look better than the U.S., they aren’t exactly exciting buys. Europe, excluding the U.K., is seen as overvalued on three of the five metrics, including all CAPE and both forward and trailing P/Es. On the other two categories, it is simply fairly valued. The U.K. by itself counts as overvalued on both trailing and forward P/E, but is seen as fairly valued otherwise.

Emerging markets are also seen as overvalued in three of the five valuation categories (both forward and trailing P/Es, and dividend yields). However, they are undervalued on the CAPE metric, which comes in at 15, below the long-term average of 16.

Japan is the only region not to be significantly overvalued on any of the five metrics. While it is slightly elevated on price-to-book and the CAPE ratio, it is modestly undervalued on forward P/E and dividend yields. The trailing P/E, at 16, is more than 10% below its 15-year average of 18.

Reference:

Ryan Vlastevica, This 1 chart shows the U.S. stock market is the most expensive in the world www.marketwatch.com