From my blog Jeremy Grantham's Expected Market Returns-Next 7 Years, Grantham says that expected real returns for US stocks are now negative for the next 7 years: meaning that US stocks are expensive.
From Mebane Faber Research, they point out that corporate earnings always revert to the mean and that to ignore the CAPE (the cyclically adjusted PE or Shiller PE) is to do so at your own peril. (CAPE is the current S&P 500 price divided by the 10 year earnings average. It's supposed to smooth out peaks and valleys to give a long term view of market valuations.)
The market's current Shiller PE (CAPE) is 23.7 which is above the long term average of 16.5. By this measure, you could say that the market is overvalued by about 40%.
Furthermore, compared to some 40 investable markets, the US is 2nd most expensive market now. From Mebane Faber Research:
There are well over 40 investable countries in the world, why just settle for one? We have shown numerous times that selecting countries on a relative basis on CAPE works great to not only pick winners, but also to avoid the bubbly losers. And according to CAPE, the US is the second most expensive market we track right now…and according to 1 year PE, it is the 4th most expensive…and according to P/B…etc
If you do a composite across 10PE, 1PE, FCF, P/B, and dividends…the US is still the 4th most expensive…
Corporate Earnings Always Revert to the Mean
It's hard to remember at a market top that corporate earnings always revert to the mean. Earnings are very volatile! They go down in recessions. Check out this chart from Mebane Faber Research showing the cyclic-ality of corporate earnings. Notice how European corporate profits are double-dipping now.
|Profits Always Mean-Revert: US and Europe profits Vs Their 10 Year Moving Average|
At the peak of the cycle, when profits are far above average and the economy is doing well, it is hard to imagine earnings collapsing back below the average, as it is to imagine a depressed region recovering. Mean-reversion in earnings, though sometimes delayed, is as undeniable as the economic cycle itself. Cyclically adjusted (or trend) PE calculations will always give a conservative valuation estimate. But that is exactly the point of valuation – to offer a degree of safety (a margin of error) and to smooth the dangers of the economic cycle. That peak profits typically accompany peak valuations only reinforces the point.Here's a chart showing how earnings volatility appears to be increasing. It also shows how we get short-sighted our thinking is. In short, the business cycle is not dead! From TheShortSideofLong blog:
|The Corporate Earnings Cycle 'Amplitude' Appears to Be Increasing|
Another chart showing the 'swings' in S&P 500 Earnings from Crestmont Research:
|S&P 500 Reported Earning and the Shiller PE|