Stocks are expensive – compared to what?

Investors are much better off focusing on facts rather than feelings. If you “feel”, he market has been rallying for a long time, so it’s got to go down soon then have on mind that bull markets don’t die of old age. There’s no rule stating that a bull market must end after a certain time. Historically, bull markets end because of some combination of over-aggressive tightening or other policy errors that cause a recession, war or other geopolitical shocks, hyper-inflation or overheating speculation.
War is always a risk.Geopolitics look unstable but the Fed has been easing, inflation is low and the economy is improving. This rally is nothing like the 90s, when everybody including their grandmother were trading tech stocks. Today, the market is dominated by institutional algorithms rather than individual speculators. There is no widespread excitement about the stock market. This rally continues with an absence of faith. Big banks even publish “doomsday calls” from the past decade. They reflect fears and disbelief in the rally.
On another note: This bull market is the longest lasting so far, but not the biggest. The current bull market started in March 2009. In 2018, it surpassed the 1990s rally as the longest in history. However, the 1990s run was larger in magnitude, rising 417% compared with the 367% we’ve seen so far in the current rally.
The conventional definition of a bull market does not include pullbacks of 20% or more. There have been downturns about 20% in 2011 and in late 2018 to early 2019. The market was effectively flat from September 2018 to October 2019. The market has had a great run. But it hasn’t been a smooth ride higher and it hasn’t been easy to stay invested. A lot of people got scared of the volatility and sold at some point. A lot of private investors never got the chance to get in again.
If you “feel” stocks are expensive then check this out: Based on the past 12 months of results, the PE of the S&P 500 is 24, high by historical standards. Considering the cyclically adjusted P/E (CAPE) ratio of 32, created by famed Yale professor Robert Shiller, the situation is even worse: It is double the long-term average. The “E” in a conventional P/E ratio uses earnings from the prior 12 months. The CAPE ratio looks back at 10 years of earnings. Professor Shiller’s metric looks back for a decade in order to adjust for inflation and smooth out the effect of short-term events, such as the Great Recession. Also known as the Shiller P/E, this metric has been higher only two times in history: 1929 and 1999!!! The alarm bells are ringing. Stocks are not only looking expensive, they look dangerously expensive!
But not so fast: Everything is priced on a relative basis. We are comparing history. But individuals investing today aren’t choosing between buying today’s stocks and stocks in 1982 or 2009, when they were historically cheap. Instead, today’s investors are comparing stocks with other options, usually bonds. Stocks compared to bonds don’t look very expensive at all. In fact, they look very attractive:
The dividend yield of the S&P 500 is 1.87%, which beats the yield on a 10-year Treasury of 1.77%. Not often, we see dividend yields higher than bond yields. If you add stock buybacks to dividends (and you should), the shareholder yield of the S&P 500 is more than 5%, according to Yardeni Research. By this analysis, stocks offer much better value than bonds.
So, if you “feel” stocks are expensive, then ask yourself “compared with what?”

Sven Franssen