Stocks are Somewhere Between Tremendously and Enormously Overvalued

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My business is to constantly look for new stocks by running screens, endlessly reading (blogs, research, magazines, newspapers), looking at the holdings of respected investors, talking to a large network of investment professionals, attending conferences, scouring through ideas published on value-investor networks and finally, scouring a large (and growing) watch list of companies to buy at a significant margin of safety.

With all of that, my firm is having little success finding solid companies at attractive valuations.

Don’t just take my word for it. Take a look at several charts, below, that show the magnitude of the stock market’s overvaluation and, more importantly, put it into historical context.

Each chart examines stock market valuation from a slightly differently perspective, but each arrives at the same conclusion: the average stock is overvalued – somewhere between tremendously and enormously. If you don’t know whether “enormously” is greater than “tremendously” or vice versa, don’t worry, I don’t know either. But this is my point exactly: When an asset class is significantly overvalued and continues to get overvalued, quantifying its overvaluation brings little value.

Let’s go to the charts. The first chart shows price-to-earnings of the S&P 500 in relation to its historical average. The average stock today is trading at 73% above its historical average valuation. There are only two other times in history that stocks were more expensive than they are today: just before the Great Depression hit and in the 1999 run-up to the dotcom bubble burst.

Source: https://www.advisorperspectives.com/dshort

We know how the history played in both cases – consequently stocks declined, a lot. Based on over a century of history, we are fairly sure that, this time too, stock valuations will at some point mean-revert and stock markets will decline. After all, price-to-earnings behaves like a pendulum that swings around the mean, and today that pendulum has swung far above the mean.