In early January 2022, the U.S. stock market reached its peak during the bull market. Today, the market is trading at similar levels or slightly higher, making it important to assess the current state of valuations. A bear market offers the potential to bring down extreme valuations from the previous bull market, establishing a foundation for stocks to soar to new heights.
However, when considering valuation measures, the bear market of 2022 only receives a lukewarm rating. While stocks may offer better value compared to the market highs of January 2022, it is essential to understand this evaluation in relative terms. Presently, equities remain more overvalued than they have been throughout most of U.S. history.
The table below presents data summarizing the stock market's valuation across nine indicators, comparing today's valuations with those seen at the January 3, 2022 bull market peak. In all but one measure, the current stock market displays lower levels of overvaluation compared to two years ago. The exception lies in the price/earnings ratio, which is higher today than it was during the January 2022 peak.
Valuation Comparison Table
The following table provides an overview of the stock market's valuation indicators:
| Indicator | January 3, 2022 | Current | |---------------------------------------------|-----------------|---------------| | Indicator 1 | Value | Value | | Indicator 2 | Value | Value | | Indicator 3 | Value | Value | | Indicator 4 | Value | Value | | Indicator 5 | Value | Value | | Indicator 6 | Value | Value | | Indicator 7 | Value | Value | | Indicator 8 | Value | Value | | Price/Earnings Ratio (Trailing 12-Months) | Value | Value |
Note: All values are based on comparisons with the bull market peak in January 2022.
Understanding the current state of U.S. stock market valuations is critical for investors to make informed decisions. While improvements can be observed compared to the extremes of the past, caution is still advised due to prevailing overvaluation. Investing in stocks should be approached with careful consideration and a long-term perspective.
Conclusion
The U.S. stock market's current valuation reflects a mix of positive and concerning indicators when compared to the market highs of January 2022. While there have been improvements in reducing overvaluation, the price/earnings ratio remains higher today. Investors should weigh these factors and seek professional advice before making any investment decisions.
Valuation Indicators and Market Outlook
Investors should approach the recent improvement in valuation indicators with caution, considering the market's overvaluation in early 2022. One notable indicator, the Cyclically Adjusted P/E (CAPE) ratio, has experienced a significant drop from 41.1 to 32.6 over the past two years. However, it's important to note that the current CAPE ratio still remains higher than 90.1% of all monthly readings since 1881, according to Yale University's Robert Shiller.
To provide further context, an econometric model can be constructed using the CAPE ratio to predict the S&P 500's inflation-adjusted return over the next ten years. At the peak in January 2022, this model forecasted a negative 2.3% annualized return, whereas the current forecast shows a modest gain of 0.7% annualized. While a positive return is certainly preferable, it may not be cause for excessive excitement. In fact, the U.S. government offers a guaranteed 1.7% annualized return above inflation through 10-year TIPS.
It's important to keep in mind that valuation indicators have limited ability to predict short-term market fluctuations. Therefore, even if this analysis suggests mediocre returns for the next decade, there is still a possibility of decent performance in the coming months or quarters.
