It seems like almost every day someone asks me if the stock market is too high and therefore due for correction. Doesn’t an all-time high for the S&P 500 mean it is more likely to go down than up from here, especially given that it has been at this level twice before, and both times, those highs were followed by two of the worst market declines since the Great Depression?
Let me first say that, as always, this note is not intended in any way to be a prediction of the future. Rather, my aim is to put the current market conditions in context with the previous two high points.
The first time the market reached the level it is at today was in March 2000, when the S&P 500 hit 1,530. At that time, the earnings from those 500 companies totaled $56, so the index was trading at 27 times the earnings (1,530 over 56) from the underlying companies.1 Let’s flip that around. What it means is that if you had invested $1,530 into those 500 largest U.S. companies in 2000, as a part owner of all those companies, you would have earned 3.7% in profits on your investment (56 over 1,530). At that time, you may recall, the index was competing with a yield on the 10-year U.S. Treasury bond of 5.8%.2
The second time the market reached the level it is at today was in October 2007, when the S&P 500 soared to 1,565. At that time, the earnings from the companies in the index were $83; so the index was trading at 19 times the earnings and the earnings were yielding 5.3%. Meanwhile, the yield on the 10-year U.S. Treasury bond was 4.5%. Clearly, U.S. stocks were cheaper in 2007 in terms of earnings and somewhat more attractive relative to bonds than they were in 2000.3
That brings us to the present market high of 1,540 as of March 2013. The actual earnings in 2012 were $1024 (forget about 2013’s expected earnings, which are even higher), meaning the index is trading at only 15 times the earnings and the profit from the 500 companies is yielding 6.6%. This is happening in an economic environment where the yield on the 10-year U.S. Treasury bond is paltry 1.9%.
This is all more numbers than I care to keep track of in my head, so let’s summarize the three events in a simple table:
| Date | S&P 500 High | Earnings, Multiplier, Yield | 10-Year US Treasury Yield |
|---|
| March 2000 | 1,530 | $56, 27x, 3.7% | 5.8% |
| October 2007 | 1,565 | $83, 19x, 5.3% | 4.5% |
| March 2013 | 1,540 | $102, 15x 6.6% | 1.9% |
As indicated by our table, the stock market, at roughly the same price level it was 13 years ago, is selling for nearly half the multiple of earnings it was then, and the yield on those earnings is over three times that of competing bond yields (instead of being well below bond yields as it was then). Is this a lofty market? Not by these objective standards. Does that mean stocks have to go up from here? Of course not, but the point is to encourage you to reason with your financial advisor about the right portfolio for you based on facts, rather than allow emotions and simplistic descriptions of “market highs” to interfere with sound judgment.
Regards,
Darius Gagne, PhD, CFA, CFP®, MBA
Chief Investment Officer
Note from Our CIO: Is the Market Too High?
The Abacus Investment Committee
It seems like almost every day someone asks me if the stock market is too high and therefore due for correction. Doesn’t an all-time high for the S&P 500 mean it is more likely to go down than up from here, especially given that it has been at this level twice before, and both times, those highs were followed by two of the worst market declines since the Great Depression?
Let me first say that, as always, this note is not intended in any way to be a prediction of the future. Rather, my aim is to put the current market conditions in context with the previous two high points.
The first time the market reached the level it is at today was in March 2000, when the S&P 500 hit 1,530. At that time, the earnings from those 500 companies totaled $56, so the index was trading at 27 times the earnings (1,530 over 56) from the underlying companies.1 Let’s flip that around. What it means is that if you had invested $1,530 into those 500 largest U.S. companies in 2000, as a part owner of all those companies, you would have earned 3.7% in profits on your investment (56 over 1,530). At that time, you may recall, the index was competing with a yield on the 10-year U.S. Treasury bond of 5.8%.2
The second time the market reached the level it is at today was in October 2007, when the S&P 500 soared to 1,565. At that time, the earnings from the companies in the index were $83; so the index was trading at 19 times the earnings and the earnings were yielding 5.3%. Meanwhile, the yield on the 10-year U.S. Treasury bond was 4.5%. Clearly, U.S. stocks were cheaper in 2007 in terms of earnings and somewhat more attractive relative to bonds than they were in 2000.3
That brings us to the present market high of 1,540 as of March 2013. The actual earnings in 2012 were $1024 (forget about 2013’s expected earnings, which are even higher), meaning the index is trading at only 15 times the earnings and the profit from the 500 companies is yielding 6.6%. This is happening in an economic environment where the yield on the 10-year U.S. Treasury bond is paltry 1.9%.
This is all more numbers than I care to keep track of in my head, so let’s summarize the three events in a simple table:
As indicated by our table, the stock market, at roughly the same price level it was 13 years ago, is selling for nearly half the multiple of earnings it was then, and the yield on those earnings is over three times that of competing bond yields (instead of being well below bond yields as it was then). Is this a lofty market? Not by these objective standards. Does that mean stocks have to go up from here? Of course not, but the point is to encourage you to reason with your financial advisor about the right portfolio for you based on facts, rather than allow emotions and simplistic descriptions of “market highs” to interfere with sound judgment.
Regards,
Darius Gagne, PhD, CFA, CFP®, MBA
Chief Investment Officer
Sources
1 Nick Murray Interactive, Volume 13, Issue 4, April 2013.
2 Ibid.
3 Ibid.
4 Ibid.
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