The U.S. stock market started the second half of the year significantly overvalued as both Warren Buffett (Trades, Portfolio)’s market indicator and the Shiller price-earnings ratio remain near respective 10-year highs.
Buffett’s market indicator remains above 140% despite continued trade war fears
CNBC columnists Fred Imbert and Alexandra Gibbs said on Monday that the Dow Jones Industrial Average shed “nearly 200 points” during the first hour of trading on continued trade war fears between the U.S. and “its key trade partners.” Despite this, the Berkshire Hathaway Inc. (BRK.A, Financial)(BRK.B, Financial) CEO’s market indicator stood at 142.1%, approximately 6.4% from its all-time high. Figure 1 shows the historical trend of the Wilshire 5000 index and gross domestic product, while Figure 2 shows the historical trend of the ratio.
Figure 1
Figure 2
According to Figure 3, the U.S. stock market is expected to return -1.9% per year based on the current market level, assuming that the ratio of market cap to gross domestic product reverts to a mean of 80%.
Figure 3
Shiller price-earnings ratio also near 10-year high
Yale professor Robert Shiller measures market valuations using a cyclically-adjusted price-earnings ratio over a 10-year period. As Figure 4 illustrates, the current Shiller price-earnings ratio of 31.8 is approximately 0.4 below the 10-year high of 32.1 and 88.2% higher than the historical average of 16.9.
Figure 4
Unlike the regular price-earnings ratio, which only considers the trailing 12 month earnings, the Shiller price-earnings ratio considers the inflation-adjusted earnings over the past 10 years. Peter Lynch warned that for cyclical companies, the regular price-earnings ratio can be artificially low in bull markets and artificially high in bear markets. Figure 5 shows the historical trend of the price-earnings ratio for the Standard & Poor’s 500 index.
Figure 5
As Figure 5 illustrates, the price-earnings ratio reached an all-time high of 123.3 during first-quarter 2009. However, although the S&P 500 was near a 10-year low of 695.19, the trailing 12-month earnings per share was just $6.86, as Figure 6 illustrates. Thus, the S&P 500 was trading at least 101 times trailing 12 month earnings.
Figure 6
See also
GuruFocus Forum users have shared thoughts about good investments during a significantly overvalued stock market. According to a previous article, companies that make the undervalued predictable and Buffett-Munger screeners offer good growth and value potential according to the co-managers of Berkshire Hathaway. Such companies include Alliance Data Systems Corp. (ADS, Financial) and Gentex Corp. (GNTX, Financial).
Disclosure: No positions.
