Valuations are so stretched that it may not take much more straw to break the camel’s back. – MarketWatch photo illustration/iStockphoto
Almost all valuation indicators with decent track records suggest that the stock market is not just overvalued — it’s extremely overvalued.
That doesn’t necessarily mean the stock market will immediately decline significantly — though anything is possible. Valuation indicators are more helpful for long-term forecasting than short-term market timing.
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It’s nevertheless worth focusing on these indicators because they provide context for Wall Street’s current focus on the burgeoning federal debt, an intractable war in the Middle East and a possible AI bubble — to name just a few of the worries du jour. It would be one thing if these worries came when the market were undervalued, and quite another, like today, when valuations are so stretched that it may not take much more straw to break the camel’s back.
The accompanying chart paints the picture. It shows the implicit return projections for nine valuation indicators, each chosen because of its statistically significant track record in forecasting the S&P 500’s subsequent 10-year real total return. Notice that seven of the nine are projecting that the S&P 500 SPX will significantly lag inflation over the next decade, while an eighth is projecting a flat real return. Only one of the nine projects a decent return above inflation, though still well below historical norms.
The average projected return of all nine indicators is a total real return of negative 3.2% annualized over the next decade.
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I am focusing on these nine indicators in tandem because, when focusing on this or that indicator in isolation, the bulls often can point to possible theoretical objections to its message. That becomes more difficult when focusing on nine different indicators with distinct ways of measuring overvaluation.
Of the nine indicators plotted in the above chart, the one…
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