Is the stock market overvalued?

The S&P 500 forward P/E looks like the late 90's tech bubble. But here's why it's different. 4 Reasons the S&P 500 is Not Overvalued In recent columns, I have written extensively about the seeming ‘disconnect’ between the economic recovery (weak) and the stock market (strong). I won’t rehash those arguments here, but the overarching takeaway is that the stock market almost always moves well in advance of an economic and earnings recovery. If an economic recovery is expected to pick up steam twelve months from now, the stock market is likely to make its move today. In my view, that’s what we’re seeing right now. An investor who accepts this argument may also wonder when the stock market is over-pricing a recovery. Or, simply put, when does the stock market become overvalued relative to future earnings and growth? Many would say the stock market is already overvalued. On June 30, the forward P/E on the S&P 500 was 21.7x, which is considerably higher than the 10-year average of 15.1x. In fact, the S&P 500 has not traded at this high of a multiple since the late 1990’s, in the run-up to the tech bubble.1 Does this mean we’re in another period of “irrational exuberance”? I do not believe so, for four reasons. --------------------------------------------------------------- [In Times Like These, Focusing on Data and Not Media Hysteria is Key!]( We have past the middle of 2020, and it has been a chaotic year of events to say the least. Still there is money to be made. So instead of focusing on the “what if’s” that saturate the media, I recommend staying calm and focusing on the fundamentals. To help you do this, I am offering all readers our just-released Stock Market Outlook report. This report contains some of our key forecasts to consider such as: - S&P 500 yearend targets - Is it time to buy stocks? - What should you think about ‘unbelievable’ jobs data? - International outlook - Zacks Rank S&P 500 sector picks - Impacts of Coronavirus - And much more. If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [IT'S FREE. Download the Just-Released August 2020 Stock Market Outlook2]( --------------------------------------------------------------- 1. The Fed Model Suggests Stocks Can Go Higher Without getting too into-the-weeds, the Fed model is a way of valuing the stock market that compares the forward earnings yield (the inverse of the P/E ratio) of the stock market with the 10-year U.S. Treasury bond. For illustrative purposes, let’s say the yield on the 10-year U.S. Treasury bond is 5%, and the forward earnings yield on the S&P 500 is 6%. In this case, an investor might do better with stocks, but may ultimately decide that the 1% difference is not worth the additional risk. If the yield on the 10-year Treasury is 1% and the earnings yield on the S&P 500 is 5%, investors usually choose stocks. Today, the forward earnings yield of the S&P 500 is over 4%,3 and the 10-year U.S. Treasury bond closed the second quarter with a yield of 0.66%.4 When extra liquidity is looking for a place to go, and the choice is between stocks and bonds, stocks look far more attractive on a relative basis. What’s more, all signs also point to the Federal Reserve repeating its post-2008 Financial Crisis playbook of leaving the federal funds rate near the zero bound for at least a few years. Historically, a forward P/E of 18x or 20x on the S&P 500 was viewed as fairly expensive, but at the same time, interest rates never been this low for this long. It was once outlandish to think the S&P 500 could trade at 25x forward earnings, but with the current interest rate outlook, it feels more possible than unlikely, in my view. 2. Tech Companies Make Money – Lots of It The last time the S&P 500 traded over 20x forward earnings for a sustained period was 1997 – 1999, with the index topping out at around 25x.5 But looking back, we now know there were basically no earnings supporting tech’s astronomical rise. Today, tech companies are leading the way with sales growth, earnings growth, and arguably reshaping the modern economy as we know it in the process. The pandemic is accelerating these changes, in my view. Not the other way around. 3. The Very Worst of the Crisis is Behind Us Cases of Covid-19 are rising, so there is no argument to say that the spread of the pandemic is improving. What has changed between April and today, however, is a better understanding of how to test, treat, and care for patients who become infected. There are also more hospital beds and medical supplies available to handle case surges. From an economic standpoint, I agree that the longer this crisis drags on, the longer and more difficult the economic road to recovery will be. But at the end of the day, recessions end when economic growth begins – even if that growth is merely a trickle at first. In my view, the very worst of the economic crisis is behind us, and markets are looking ahead to what the economy could look like at this time next year. 4. You Really Cannot Fight the Fed and Fiscal Stimulus The world has never seen this type of liquidity event before. Drawing from lessons of past crises, the Federal Reserve and Congress acted quickly and decisively with extraordinary stimulus measures. This stimulus is not unique to the United States, either. Developed countries around the world and China are pulling the monetary and fiscal levers too, with total fiscal and monetary stimulus now amounting to approximately 28% of world GDP. When money supply growth exceeds nominal GDP growth, as is presently the case (by a long shot), this liquidity flows through the capital markets—pushing asset prices higher in the process, in my view.6 The stimulus may increase from here. In a congressional hearing at the end of June, Federal Reserve Chairman Jerome Powell and Treasury Secretary Steven Mnuchin both pledged to consider additional relief measures to support the economy as the pandemic drags on. It is difficult to make a bearish case when this ‘wall of liquidity’ looms in the backdrop. Bottom Line for Investors Considering the four reasons detailed above, in my view it is not outlandish to imagine a scenario where the S&P 500 trades at 23x, 25x, or even higher multiples. I am not declaring that the S&P 500 will trade at these valuation multiples – just that it could. If the S&P 500 were to trade at 25x 2021 earnings of, say, $160 a share, that would imply an S&P 500 at 4,000. In my view, this type of outcome is actually more possible today than it is unlikely. For now, we will have to wait and see, but staying patient in times like these is no small feat, so to help you focus on the fundamentals instead of the fearsome headlines, I am offering all readers our [Just-Released August 2020 Stock Market Outlook Report](. This Special Report is packed with newly revised predictions that can help you base your next investment move on hard data. For example, you'll discover Zacks’ view on: - S&P 500 yearend targets - Is it time to buy stocks? - What should you think about ‘unbelievable’ jobs data? - International outlook - Zacks Rank S&P 500 sector picks - Impacts of Coronavirus - And much more. If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [FREE Download – Zacks' August 2020 Stock Market Outlook Report7]( --------------------------------------------------------------- ABOUT ZACKS INVESTMENT MANAGEMENT Born from Research – Built for Performance Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. At Zacks Investment Management, we work with clients with $500,000 or more to invest, and we use this independent research, 35+ years of investment management experience, and tools we’ve developed to design customized investment portfolios based on each client’s individual needs. The end result is investment management that is research driven, results oriented and client focused. Ready to get serious about pursuing your financial goals? Call [1-800-701-9830](tel:8007019830) today, or schedule a time with a Zacks Wealth Advisor. © Zacks Investment Management | [Privacy Policy]( 1[J.P. Morgan, June 30, 2020.]( 2 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion. 3[S&P 500 earnings Yield, July 7, 2020.]( 4 Board of Governors of the Federal Reserve System (US), 10-Year Treasury Constant Maturity Rate [DGS10], retrieved from FRED, Federal Reserve Bank of St. Louis; July 6, 2020. 5[J.P. Morgan, June 30, 2020.]( 6[Charles Schwab, June 19, 2020.]( 7 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion. 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