Investors are always bombarded with articles suggesting the market is overvalued, and presumably ready for the next major decline. I don’t pay much attention to such blathering because I have heard this same story in one form or another over and over again in my 32 years as an advisor. I think the stock market is simply misunderstood and could even be considered under-valued by several metrics.
Four years ago I titled my newsletter “Never Been More Bullish.” This was during the time when many pundits were calling for “the next shoe to drop” in the stock market. At that time I decided to focus on a couple of things that suggested that perhaps most were missing some valuable reasons to be optimistic about the stock market.
The first was the fact that the dividend yield on the Standard and Poor’s 500 Index provided a yield than a ten year treasury. That meant investors could not only expect to earn a higher dividend stream from the 500 largest companies in America from the get-go, but they would also be entitled to a (potentially) rising income stream and a share of any earnings increases for the next ten years. This was important at the time because it rarely happens, and had not occurred since 1958 when the Dow was trading in the 500-600 range. That suggested to me that the stock could have been considered under-valued.
That letter was not a market call. It was more to draw attention to reasons to be optimistic during a rough period when people were losing faith in the markets. But I also found we had another reason to be optimistic.
In addition to the dividends are actually paid, you can consider the actual company earnings from which those dividends are paid. I wrote that “If we divide the current earnings of $105 by the index value (at that time) of 1,275, we get an earnings yield of just about 8.25%.” I went on to write, “Compare that with the yield for the 10-year treasury bond of 1.60%….Looking at this relative comparison, the last time stocks were as undervalued relative to bonds was during the great depression.” Once again, this was not a market call, I was just taking into consideration the relative dividend yields and earnings yields for the broad US stock market compared to what investors could earn from a 10-year treasury bond and recognizing how favorable stocks looked.
Which brings me to today… is the market overvalued now?
It now seems obvious that the market was not “over-valued” 4 years ago. But after an almost 65% increase since then, many people may start to wonder if it is over-valued now.
Fortunately, we can take comfort in the same metrics that made me optimistic 4 years ago. Today the dividend yield on the Standard and Poor’s 500 Index (2.1%) is higher than the current yield on the 10-year Treasury bond (1.36%). So once again, investors in the broad US stock market can expect a higher income stream relative to bonds to being with, with the added bonus of a claim on potentially rising income as well.
When I calculate the earnings yield of the Standard and Poor’s 500 Index (earnings divided by the index price), I get a current earnings yield of 5.75%. If I look at next years estimated operating earnings, I get an earnings yield of 6.10%. While an earnings yield of around 6% is not as high as it was in 2011 or 2012 (when it was closer 8.25%), it still suggests to me that the broad US market looks very favorable when you consider a 10 year treasury is yielding only 1.36%.
Once again, I am not making a market call, and anyone who knows my investment philosophy knows I never will. All I am suggesting here is that I just don’t see where the pundits come up with a view that the stock market is very much overvalued. I think I will stick to my opinion that if anything, the market is under-valued.
That is why, though the stock market has had an incredible run, I just can’t help but be bullish after all these years.