Turn on CNBC and you’ll be bombarded by dooms-day prognosticators. “Feds around the world has gone nuts …. too much cheap money ….. market is crazy… market is on steroid … watch out ! bubble will burst….” Really ?
I decided to dig deeper. I think I’ll just keep it really simple :
To say the market has gone too high and it’s a bubble, I take it to mean that stock prices are now at a level that is unsupported by earnings, aka unreasonably high P/E. But what P/E ratio is considered too high?
I downloaded the data from Standard and Poor’s website. Here’s what I got :
There are some years during the 2001 and 2008 market crash when the P/E ratio was completely out of whack. I excluded those and took the average. It came out to be about 18.
Currently S&P500 P/E ratio is 17.4, based on reported earnings as of Sept 2013. Compared to historical data, 17.4 is average. Definitely can’t be considered a bubble.
Another way to look at whether P/E is too high is really to reverse it and look at E/P. That’s the earning’s yield. The current earning yield is 5.75%. Compared to the 10 year treasury yield of 2.65%, the yield spread is 310 basis points. Again, the yield spread is higher than long term average. Therefore the stock market cannot be called a bubble at the current price with any stretch of the imagination. I would consider it fairly price.
I look further into the P/Es of other markets. I found that the P/Es of Europe and Asia are even more lucrative.
Yes, I agree – we must not just simple invest in a market because the P/E ratio is low. Granted. However, current facts gave me strong confidence to stay in equity despite the fact that majority of the world equity markets have appreciated substantially in the last 3 years. I will probably shift more money to some Asian markets which I’m familiar with as well as some European markets as well in 2014.