Up, Up, and Away
Stocks still look inexpensive even as the bull market continues to hit new highs
You can use any number of words to describe this bull market, including old, unpredictable, irrepressible, and record setting. Frothy is not one of them.
Despite a 4
"It's almost unprecedented to see a cheaper market 4
Why are investors convinced that this market is cheap? The most commonly used yardstick to gauge market valuations is the price-earnings ratio. Right now, the P/E ratio for the S&P500 index is about 18, based on earnings for the past four quarters.
By historic standards, this isn't dirt cheap, but it's substantially lower than the market's P/E of 27.1 at the start of this bull market, on Oct. 10, 2002. It also runs counter to history. In the past, bull markets that have survived to their fourth birthdays have typically seen their P/E ratios climb-by about 28 percent on average.
Market strategists and money managers say stocks are now particularly cheap in light of the current state of the economy. For example, in past periods when inflation has run between 2 percent and 3 percent-which is the case today-the S&P500's P/E has averaged 19.7. And when long-term bond yields have been about where they stand today-which is under 5 percent-investors have been willing to pay 22.8 times the S&P's earnings.
Considering all of these factors, "the market is very reasonably priced, to the point of being cheap," says David Kovacs, head of quantitative research at Turner Investment Partners. This is one reason Kovacs thinks equity prices could "accelerate to the upside from here," he says.
Using his own gauge of market valuations, Tobias Levkovich, chief U.S. equity strategist for Citigroup Investment Research, thinks that domestic stocks could be undervalued by as much as 20 percent.
Does that mean the market will soon rise an additional 20 percent? Not necessarily.
New high? Think of it this way. If the S&P 500's current P/E of 18 were to rise even a single point to better mirror its historic average, "it would be worth about 6 or 7 percent on the market," says Jeffrey Kleintop, chief market strategist for LPL Financial Services. This means the S&P 500 index could easily move up an additional 90 to 100 points, which would send the index back above its all-time record high of 1527, set on March 24, 2000.
Here's the even better news: In past periods when the S&P 500 has set new all-time highs, it didn't just stop there. It kept going for months, if not years. Indeed, since 1942, stocks have gained an additional 5.2 percent on average in the six months following the establishment of a new S&P high.