Are U.S. Stocks Overvalued?

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U.S. Stock Risk

There’s a nice article this week by Ron Delegge entitled, “Are U.S. Stocks Overvalued” which reads in part,

The year isn’t even half over, and the S&P 500 has already advanced almost 18% year-to-date. Plus, the value of the S&P 500 has jumped more than 5% during the first two months of the second quarter.

Globally, U.S. stocks are outperforming most developed and emerging-market countries.

Have stock values become overstretched?

“The forward 12-month P/E ratio for the S&P 500 now stands at 14.4, based on [May 16’s] closing price (1650.47) and forward 12-month EPS estimate ($114.94),” Factset wrote earlier this month. “This is the highest forward 12-month P/E ratio logged by the S&P 500 in more than three years (April 2010). Given the high values driving the P in the P/E ratio, how does this 14.4 P/E ratio compare to historical averages? Is the index now overvalued?”

On the one hand, the index is now trading above both the 5-year (12.9) and 10-year average P/E ratios, the research firm points out. On the other hand, it is still trading below the 15-year average P/E ratio (16.5), and is not close to the peak P/E ratio of 25 recorded in the late 1990’s and early 2000’s.

The PE10 (also known as the Shiller P/E ratio) is another measure of valuations.

Currently, the S&P 500’s PE10 is at 24.8, which puts it above its historical median of 15.89. While that may seem elevated, it’s still below its 1999 peak of 44.20.

Regardless of if the market continues to go up or if it corrects one of these statistics will be touted as the rationale that such a move should have been obvious. Delegge’s article (and the market’s continued movement upward) is evidence that valuation statistics such as these at best only change the odds. There is no such thing as certainty in the markets and they are inherently volatile.

When the S&P 500 is the best performing asset class, any amount of diversification into other asset classes can be disappointing. But such diversification is nevertheless not a mistake.

A balanced portfolio holding U.S. stocks, foreign stocks and resource stocks is still the best tactic to hedge against inflation and secure the financial independence necessary for retirement. We have a saying within the firm, “It is always a good time to have a balanced portfolio.” This is true even during months when the S&P 500 is the best or worst performing index.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818…)