US Stock Market Valuation Indicator

Stock market pricing indicates whether stocks are cheap or expensive in relation to earnings, but is a poor indicator of market timing. We do not recommend selling stocks when market valuations are high, but advise caution when adding new positions.

Stock Pricing

US stock pricing eased slightly to 95.09% from 95.73% last week, with a recent low of 91.79% four weeks ago.

We use z-scores to measure each indicator’s current position relative to its historical data, with results expressed in standard deviations from the mean. We then calculate an average of the five readings and convert that to a percentile. The higher the stock market price measure is relative to the historical mean, the greater the risk of a sharp drawdown.

Buffett Indicator

Warren Buffett’s favorite long-term measure of stock market valuation compares stock market capitalization to GDP, providing a stable, long-term ratio unaffected by fluctuating profit margins. The ratio reached a new high of 3.08 this week, more than double its long-term average of 1.2.

Dow Jones Industrials Price-to-Sales

We use a 20% trimmed mean when calculating the Price-to-Sales ratio for the 30 stocks in the Dow Jones Industrial Average to remove the most extreme readings that would otherwise distort the ratio. The ratio has risen to a new high of 4.04.

Dow Jones Industrials Forward PE

We use a similar 20% trimmed mean when calculating the Forward PE for stocks in the Dow Jones Industrial Average to avoid distortions. The Forward PE is also close to making a new high.

Shiller CAPE

Robert Shiller’s CAPE compares the S&P 500 index to its 10-year average of inflation-adjusted earnings to minimize business-cycle distortions. The current peak of 39.5 is the second-highest in history, behind only the Dotcom bubble in 2000, and well above its long-term average of 22.4.

PE of Highest Trailing Earnings

The S&P 500 Price-Earnings (PE) ratio compares the current index value to the highest trailing earnings to minimize distortions from periods when earnings fall sharply. A steep rise in earnings has lowered the ratio to 25.9, but it’s still high compared to the long-term average of 17.3.

Conclusion

The extreme pricing increases the risk of a significant drawdown.

Acknowledgments

• Prof. Robert Shiller: CAPE 10 Data
• S&P Global: S&P 500 Sales and Earnings Estimates
• Federal Reserve of St Louis: FRED Data
• Morningstar: Dow Jones Industrial Average Data