Are Stocks Undervalued Yet? – WSJ

Everyone wants to know when the stock market, after its recent declines, will be a good value again.

The sobering news is that even at its lowest point in mid-May, the S&P 500 index wasn’t even close to being undervalued according to any of eight valuation models that my research shows have the best long-term track records.

The recent bounce in the S&P 500—up 5.3% since May 19—could be just a passing bear-market rally, or it could be a new bull-market leg.

But if it proves to be the latter, it is all but certain that factors other than undervaluation are helping drive stocks higher.

The eight valuation indicators that have proved best at predicting 10-year returns, inflation-adjusted, for the stock market are a subject I have covered before. And while it is possible that other valuation models exist that are just as good at predicting bull markets, I haven’t discovered any.

On balance, these eight indicators at the mid-May low stood at more than twice the average valuation of the bear-market bottoms seen in the past 50 years. And, seen in comparison with all monthly readings of the past 50 years, the average of the eight measurements was in the 88th percentile.

CAPE fear

Let’s start by looking at the cyclically adjusted price/earnings ratio, or CAPE, made famous by Yale University finance professor (and Nobel laureate)

Robert Shiller.

It is similar to the traditional P/E ratio, except that the denominator is based on 10-year average inflation-adjusted earnings instead of trailing one-year earnings. As with the traditional P/E, the higher the CAPE ratio, the more overvalued the market.

On May 19, the CAPE ratio stood at 30.4. That is more than double the average CAPE ratio at all bear-market bottoms since 1900, according to an analysis by my firm, Hulbert Ratings, of bear markets included in a calendar maintained by Ned Davis Research. While some might think comparisons from so long ago aren’t relevant under current conditions, a…


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