We imagine this call is going to get a lot of debate going about how expensive stocks are right now, and the durability of this rally.
Goldman equity strategist David Kostin declares in his latest ‘Weekly Kickstart’ note that the market is getting pricey.
These three paragraphs pack a major punch. Bulls should take heed:
The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock: (1) The P/E ratio; (2) the current P/E expansion cycle; (3) EV/Sales; (4) EV/EBITDA; (5) Free Cash Flow yield; (6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of (6) inflation; (7) nominal 10-year Treasury yields; and (8) real interest rates. Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of (9) Operating EPS and (10) about 45% overvalued using As Reported earnings.
Reflecting on our recent client visits and conversations, the biggest surprise is how many investors expect the forward P/E multiple to expand to 17x or 18x. For some reason, many market participants believe the P/E multiple has a long-term average of 15x and therefore expansion to 17-18x seems reasonable. But the common perception is wrong. The forward P/E ratio for the S&P 500 during the past 5-year, 10-year, and 35- year periods has averaged 13.2x, 14.1x, and 13.0x, respectively. At 15.9x, the current aggregate forward P/E multiple is high by historical standards.
Most investors are surprised to learn that since 1976 the S&P 500 P/E multiple has only exceeded 17x during the 1997-2000 Tech Bubble and a brief four-month period in 2003-04. Other than those two episodes, the US stock market has never traded at a P/E of 17x or above.
As you can see in this chart, since 1976, the only times that PE ratios have been higher than where they are now were during the tech bubble.
And if you look at median PE ratios, this moment looks even richer.
What’s more, looking back through several cycles, we’re above where we normally are when the market peaks.
The rest of the note walks through other indicators suggesting market richness.
Kostin doesn’t think markets are going to tank or anything like that. Instead it’s just predicting modest gains. But still, this is a level of scepticism towards the real bull case that we’re not used to seeing at all from the street right now.