The global stock market has a constant debate on the correct and justified price that could be placed on the unknowable bets of the future. But still, there is one thing that any and all market players agree on. The stocks in United States of America are not cheap at all.
On this agreement, there is a disagreement. The disagreement that surrounds is just how expensive these stocks are. There is also a debate on whether these prices are justified. Some people also debate whether the valuation even matters in the current market.
There have been a lot of ways in which investors generally portray how company equities are valued as compared to profits that the company has and the future cash flows of the company.
There are many conservative methods, which some believe to be punitive methods too. Among them is Cyclically Adjusted Price/Earnings ratio by Robert Shiller. This is based on the earnings for S&P 500 based on the past ten year reports. This ratio is about 29 now. And this level only exceeded in the last century during the late bubble years, the 90s. Although, this measure has been looking too high for the past ten years. This is because the market had continued to march higher.
The other method is the forward and trailing Profits/Earnings. Based on the operating profits of last year, the S&P 500 is only above a 19 multiple. According to the consensus forecast for the results of 2017, S&P 500 is a bit over 18.
Whatever be the method, it is clear that these stocks have been really expensive than they were at any point of the economic cycle that is currently going on. They have also been really expensive since the end of the last major bear market. This was about eight years ago. The math, which is immutable generally, for investing always says that the richer the valuation you pay, the lower is the expectation of long term returns.
So, what is the reason behind investors paying up for stocks that are at a relatively stout valuation, or in the form of heavy inflows of equity fund, during this absolutely impressive and persistent rally phase?
Market valuations of the stock do matter, but so do psychology and emotion. This has always been and will always be the case till stock market has human participants.
We should never exclusively use market valuation for investing or not investing. That is what the investors are doing in the current market. They use the valuation and look at other key fundamental factors for a view that is complete.
Profit Strategy Newsletter of ETF uses fundamental, sentiment, and technical analysis along with common sense and market history to keep their investors on the right side of the market. The investors in the current fickle market do the same and emerge victorious.