Is the US market expensive?

The US market is trading above its long-term average … but on some measures it isn't overpriced.

By Sam Fimis · 16 May 2014

By Sam Fimis ·
16 May 2014

Summary: The first quarter earnings results from the US have exceeded analyst expectations, and the market is trading well above its long-term average. But whether the market is expensive depends on how you measure it.

Key take-out: When considering expensiveness from a P/E perspective, always consider whether returns are due to earnings growth or how much investors are willing to pay for earnings growth in the future.

Key beneficiaries: General investors. Category: Shares.

US earnings update

Hard to fault the first quarter earnings season in the US thus far. Analysts expected S&P500 earnings to lift 1.2% for the first quarter. Earnings are currently up 5.10%. The price-to-earnings ratio of S&P500 is 18.75x against the long-term average of 15.51x.
Graph for Is the US market expensive?

Is the US market really expensive?

John Mauldin produces one hell of a newsletter. In his latest ‘Thoughts from the Frontline’, he asks the question, “Are Valuations Really Too High?” He takes readers through the three different ways to look at stockmarket valuations. The first is the Shiller P/E ratio, which is a 10-year smoothed curve that takes away some of the volatility caused by recessions. Based on this metric, the market is definitely looking expensive. (Notice where the market was on Black Tuesday and Black Monday).
Graph for Is the US market expensive?

However, if you look at the 12-month trailing P/E ratio, you can conclude that stocks are moderately expensive but not in bubble territory.
Graph for Is the US market expensive?

Thirdly, if you consider the 12-month forward P/E ratio, one could argue that US stocks are reasonable priced, if not cheap.
Graph for Is the US market expensive?

Conclusion

It all depends on how you want to view the market and generate an opinion and expectation level on future performance. When considering expensiveness from a P/E perspective, you always have to consider whether returns are due to earnings growth or how much investors are willing to pay for earnings growth in the future. One thing is for sure though; if you buy equities at average valuations, you can expect average returns. If you buy equities at below average valuations, one is entitled that, at some point in the future, returns achieved will exceed the average.

Sam Fimis is a private client adviser with Patersons Securities and author of Premiership Portfolio: 6 Step Guide to Succeeding in the Stock Market, which can be found at www.premiershipportfolio.com.

The comments published are not financial product recommendations and may not represent the views of Eureka Report. To the extent that it contains general advice it has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.