For some time now I have been pointing out that the stock market as measured by the S&P 500 has become moderately overvalued. However, even more to the point, I still believe that to be true even after the price corrections we have experienced recently as a result of the coronavirus. In other words, I believe that stocks remain expensive, and therefore, might represent poor long-term returns going forward.
The following earnings and price correlated FAST Graph of the S&P 500 illustrates the veracity of my above statements. The orange valuation reference line on the graph is drawn as a 15 P/E ratio. The dark blue line is drawn as a normal P/E ratio valuation reference line is a 17.47 P/E ratio. As you can see, the market has commonly traded between those two valuation reference lines since calendar year 2000. However, you can also see that the market was overvalued in 2000 where the price was significantly above both valuation reference lines.
As a result, the S&P 500 from a performance perspective resulted in what has been called the lost decade. From January 31, 2000 through January 29, 2010 the total annualized rate of return of the S&P 500 was a -1.1%, and that includes dividends. Although this timeframe also includes both the recession of 2001 and what I call the Great Recession of 2008 – 2009, it should be clear that excessively high valuation was the main cause of poor market performance over this timeframe.
As depicted in the pop-up on the below graph, note the P/E ratio of the S&P 500 was 28.22 on January 31, 2000. As you can see in the FAST FACTS to the right of the graph, the current blended P/E ratio of the S&P 500 is 19.02. Although this is not as high as the market’s valuation we saw in 2000, it is still higher than the historical norm. On the other hand, and to be fair, today’s low interest rates might partially mitigate some of that risk considering that the current dividend yield of the S&P 500 is currently higher than the interest available from a 10 year treasury.