Is the Stock Market Overvalued? Stock Market Earnings, Valuation & Expected Returns

From a longer term investment viewpoint, you want to invest when markets are not overpriced. The median Price to Earnings ratio for the SP500 is 17.9. At the time or writing, it's over 28. Stock Market valuation and performance can factor into a Dollar/Pound cost average strategy by limiting position sizes at high P/E values.

Asset Class Returns

It is always pretty interesting from a globally diversified portfolio perspective, to keep track of the previous and current year asset class returns. The Blackrock page below provides this information and can help us gain more insight into the overall picture...

Blackrock Asset Return Map

Country & Region Performance

MSCI Is the leading provider of stock market indices from which many globally diversified funds are built. The real time MSCI chart in the link below provides a very convenient and clear snapshot of the daily and "Year To Date" performance of all world regional stock markets

MSCI REGIONAL & GLOBAL Real Time Performance

We are more interested in the broader regional markets but you may have country based funds/ETF's so you can check stock market performance at those levels from here...

MSCI REGIONAL & GLOBAL

To see the MSCI World index and MSCI World Index ex-US price charts check out the links below...

This enthusiast site is packed full of various charts for markets and sectors. The international line chart for each country shows the general trend for our globally diversified funds:-

Current Stock Market Valuation

Stock market prices and valuation tend to 'revert to the mean'. Market valuations determine their likely future direction. If valuations have strayed too far above the mean it much more likely to see a decline back to the 'mean' valuation (or 'fair price'), and vice versa... If market valuation is low then in theory, it's a better time to buy as there is a greater probability of prices rising.

The following link will take you to an excellent market valuation website (based on US equities) that calculates an aggregate index of the main market valuation models. This index represents an objective measure of whether markets are currently overvalued or undervalued...

Current Market Valuation (the homepage dial shows the current value of the index)

Professor Robert Shiller’s famous CAPE ratio is of the most well know indicators of when a stock or stock market, is over-valued. The CAPE ratio is the Cyclically Adjusted Price to Earnings ratio which averages out the standard PE ratio which is usually stated as the PE over the previous year. This smoothes out anomalies and provides a clearer signal. When the CAPE rises above 20, it’s time to start taking issue. At the time of writing the current CAPE for the US stock market is just over 38. This dwarfs the CAPE as it was just before the Financial Crisis 2008, but is still below the CAPE just before the 2000 crash.

The ‘Current Market Valuation’ button below will open up a browser tab to a great little website showing the best indicators or measures for stock market valuation. It then combines them to give an overall assessment of whether the stock markets are over, under or fairly priced. At the time of writing, not all of them are saying the markets are over-priced, although it’s hard not to think those measures are flawed in some way. (Who could really say that Buffet is plain wrong?)

CAPE RATIOS BY COUNTRY

CURRENT MARKET VALUATION

The Shiller Excess CAPE Yield is a new measure Shiller came up with to take low interest rates into account. This measure shows that the current US equity market is about average and not overpriced as nominal measures above suggest, but again what happens when low interest rates turn into high interest rates? (or even ‘normal’ interest rates).

The US stock market is generally considered to be overvalued and the analysis above backs this up with a good deal of research. As we are invested in a globally diversified ‘core’ fund/portfolio, then we are interested when the biggest stock market in the world (the US) is overvalued. Vigilance is required in order to decide if we want to rebalance, trim, reduce risk or even get out of the markets in extraordinary circumstances.

So, now we’re at the mercy of those pesky central bankers aren’t we. Any attempt to ‘normalise’ interest rates would be matched by a sell-off and likely sharp market declines. In addition to these interest rate changes, ‘tapering’ the Quantitative Easing (QE) program (central bank bond-buying / asset-purchasing / basically printing money from thin air) could also see market pullbacks and corrections.

After the extraordinary measures taken as a result of the Coronavirus pandemic central banks are almost certain to begin ‘tapering’ QE and may also be forced to raise interest rates at the same time to curb inflation which is stubbornly high.

Are Stock Markets Over-priced? What are the expected returns?

Cyclically Adjusted PE Ratio (CAPE Ratio) shows that, in nominal terms, the stock markets are overvalued… US CLICK HERE (new tab) and by Country CLICK HERE

This is a fantastic free resource valuing stock markets with the best-known valuation models. At the time of writing, It is clear that stock markets are over-valued but according to this resource, not when low-interest rates are accounted for. This just goes to show how important even small rises in interest rates will be to the value of your investments… CLICK HERE (new tab).

Even if low-interest rates can ‘explain away’ the high stock market valuations, it is still the case that the markets have shot up over the past year with interest rates changing. The following link shows the CAPE (see above) shooting up over the past year… CLICK HERE (new tab). By Country CLICK HERE (new tab)

Last but certainly not least, kudos to Blackrock for the resource below revealing their take on asset return expectations over time periods from 5 years to 30 years. This gives us more awareness about standard projections of returns. What it doesn’t do is help us detect crashes and the like. The Crash Dashboard in this blog is my stab at detecting corrections.

ASSET RETURN EXPECTATIONS

The Shiller Excess CAPE Yield is a new measure Shiller came up with to take low interest rates into account. This measure shows that the current US equity market is about average and not overpriced as nominal measures above suggest, but again what happens when low interest rates turn into high interest rates? (or even ‘normal’ interest rates).

The US stock market is generally considered to be overvalued and the analysis above backs this up with a good deal of research. As we are invested in a globally diversified ‘core’ fund/portfolio, then we are interested when the biggest stock market in the world (the US) is overvalued. Vigilance is required in order to decide if we want to rebalance, trim, reduce risk or even get out of the markets in extraordinary circumstances.

So, now we’re at the mercy of those pesky central bankers aren’t we. Any attempt to ‘normalise’ interest rates would be matched by a sell-off and likely sharp market declines. In addition to these interest rate changes, ‘tapering’ the Quantitative Easing (QE) program (central bank bond-buying / asset-purchasing / basically printing money from thin air) could also see market pullbacks and corrections.

After the extraordinary measures taken as a result of the Coronavirus pandemic central banks are almost certain to begin ‘tapering’ QE and may also be forced to raise interest rates at the same time to curb inflation which is stubbornly high.

An ETF Barometer for Market Sectors

Click Here for an interesting link showing the best performing ETF’s and which sectors they are in. At the time of writing Green tech, Cannabis and Commodities feature heavily at the top of the tree, Are they still there?

Financial Investment professionals spend their whole careers either creating/generating valuations for various asset class markets, or investing/trading from those markets. Not surprisingly then, this is probably the most often quoted fundamental indicator when assessing the timing of investing capital into the stock market...

The Buffet Indicator

Who are we to argue with the often quoted 'greatest investor of all time'... the GOAT... the one and only... Warren Buffet? Buffet has used a ratio of the total US stock market valuation to the GDP for a long time and it has served him well! (The chart below goes back to the 1950s).

Only recently Buffet liquidated billions of stocks as his indicator breached the second standard deviation as shown in the chart below. A week or so later and what do you know, the market has started coming back down from the all time highs...

Price to Earnings

The recent spike in the percentage of the market trading with PE over 30 is way above GFC levels (but still has some way to go to reach the lofty Dotcom levels (could the AI revolution/bubble take is even higher?)…

Stock Market Valuation

Financial Investment professionals spend their whole careers creating or assessing valuations for various asset class markets, and then investing/trading in those markets. Not surprisingly then, this is probably the most often quoted fundamental indicator when assessing the timing of investing capital into the stock market...

For a deep dive <<< CLICK HERE >>>

The start of 2025 was a good case study for top end stock market valuations which typically lead to poor returns. Whether that happens in 2025 remains to be seen, but investment decisions should be made on probability and when the probability is lower returns then that should factor into investment decisions and allocation.

In particular the Shiller CAPE ratio has become a gold standard for market valuation and the returns based on history are not looking great for our 2025 case study...

CAPE is the black line below and Dow is the red line

CAPE is 38 at the start of 2025

Cash Yield vs Yield from Stocks

One investment rule from Warren Buffets Investing bible ... "The Intelligent Investor" by Benjamin Graham, is to allocate more to Cash when the yield on cash exceeds that of stocks which are shown below on the highlighted lines on the chart.

These lows on the 'spread' (difference) in cash yields correspond pretty well with market tops of some form as can be seen on the second chart below.

US Stock Market Earnings

The Earnings per share and Forward earnings measures correlate very well with downturns/recessions often preceding the official recession (grey bars below). Other earnings charts also show important relationships between earnings and the economy.

A decline in company earnings is another closely monitored metric associated with downturns and crashes. If earnings start to disappoint across the board then we have a slowing economy and are likely to see job losses. It's those job losses that lead to recessions and declines in our global equity funds. Speaking of which, the Yardeni link below gives us a view of earning for global stocks so it better suited to you if you are invested in standard globally diversified stocks funds...

Factset US Earnings
Yardeni MSCI Global Earnings

Yardeni S&P 500 Earnings & Dividend Yields

Yardeni S&P 500 Earnings & The Economy

Yardeni S&P 500 Earnings Forecast/Outlook

SP500 Earnings Per Share: The US S&P500 is the largest stock market in the world and therefore takes up a significant proportion of most global funds. If earnings of these companies start to decline on a secular basis (see the chart/image below) it can spell bad news for the SP500 and therefore our global funds. So we need to keep an eye on 'trailing' and 'forward' Earnings Per Share for the SP500 and when earnings revisions go negative.

The US S&P500 earnings per share, forward and actual on the Yardeni chart below show the clear downturn in these metrics before the 2001 DotCom crash and 2008 GFC crash. The actual earnings are more sensitive to a downturn so that seems to be the one to watch. As of time of writing in 2024 both are on an upward trajectory.

CAN FORWARD EARNINGS GROWTH ESTIMATES BE TRUSTED?

A word of caution in SP500 forward estimates... they have a reputation of being overly optimistic: -

SP500 EPS Forward Estimate (Ycharts)

What can't be massaged to influence investors is ACTUAL SP500 earnings. The trend in earnings turning down is a warning sign that stocks could run into headwinds in the near to medium term.

SP500 EPS ACTUAL (Ycharts)

The medium trend will inform us where we may be heading over the next six months to a year. The longer term trend (quarterly) may give us a better idea if we are heading into a deeper drawdown. (See the DotCom bust earnings crash (2000) and GFC downturn (2008) below.

SP500 Earnings Growth Per Quarter (Multpl)

Are Corporate Earnings Heading Down?

In the previous 2 financial busts, corporate earnings started trending down way before the recessions were declared. At the time or writing in 2024 corporate earnings are heading up pointing away from recession you could argue. But. there is always a lag between changes in monetary policy and the economy. If those corporate earning start trending down it would be another tick for the case for the next crash...