“Stocks are not nearly as overvalued as some here are led to believe. P/E ratios in the 17-20 range for S&P 500 in a 5-6% interest rate environment is nearly properly valued IMO. That is based on fundamentals, not psychology.”
– FormerSanDiegan
I don’t mean to pick on you FSD, but you’re making two dangerous (albeit common) assumptions: (1) that the “E” in the P/E is “normal,” and (2) that interest rates will remain constant over the average investor’s investment horizon.
Where the “E” – earnings – is concerned, corporate profitability is at an all-time high. Unfortunately for those long stocks, corporate profitability is one of the most consistenly mean-reverting time series in all of financial history. (As Jeremy Grantham likes to correctly point out, “If profitability doesn’t mean revert over time then capitalism is broken.”) So when the “E” reverts to historical norms during and after the next recession there could be a large valuation adjustment on that count alone.
The other issue is that long-term interest rates have been known to rise from time to time, recent history notwithstanding. Change that 6% long term rate to just 7% and all of a sudden you’ve got another valuation adjustment to consider.
Finally, EVEN IF margins remain high for some time AND rates don’t increase, the S&P is only priced to return about 6%-7% annually over the next 5-10 years (that’s 1% dividend yield + 5%-6% earnings growth). Why buy stocks to return 6%-7% when you can buy a CD and earn 5.5% and take virtually no principal or duration risk? Yes, there’s a tax differential for many folks, but you see the point. You’re just not getting compensated to take stock market risk these days, so why take it? Why indeed…
