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 to, or opening, new positions.
Stock Pricing
US stock pricing increased to 95.96% from 95.09% last week, compared to a recent low of 91.79% five 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 3.16 this week, more than double its long-term average of 1.2.
Dow Jones Industrials Price-to-Sales
The Price-to-Sales ratio for the Dow Jones Industrial Average has reached a new high of 4.09. We use a 20% trimmed mean of the Price-to-Sales ratio for the 30 stocks in the Dow to remove the most extreme readings that would otherwise distort the ratio.
Dow Jones Industrials Forward PE
The Forward PE for the Dow Jones Industrial Average, at 21.33, is also close to a new high. We use a similar 20% trimmed mean of Forward PE for stocks in the Dow to mitigate the impact of outliers.
Shiller CAPE
Robert Shiller’s CAPE compares the S&P 500 index to the 10-year average of inflation-adjusted earnings to reduce business-cycle distortions. The present peak of 39.58 is the second-highest in history, behind only the Dotcom bubble in 2000, and far above the long-term average of 22.4. CAPE
PE of Highest Trailing Earnings
The S&P 500 Price-Earnings (PE) ratio increased to 26.64, compared to the long-term average of 17.3.
Conclusion
The extreme pricing indicates an elevated 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