Stocks Hardly Overvalued – Big Rally Ahead

With stock prices busting new records and price-earnings ratios appearing in bubble territory, investors may be tempted to take some money off the table. That would be a terrible mistake—a big summer rally is in the offing, and small investors who try to time the market usually miss out.

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The S&P 500 is currently selling for about 42 times current earnings, and that’s well above the 25-year average of 26 and implies an equivalent interest rate of only 2.4 percent.

Even with the recent uptick in bond yields, the ten-year Treasury is paying only about 1.6 percent. That’s significantly less than its 3.6 percent 25-year average and 2.5 percent for the 10 years prior to the pandemic. That makes stocks at current prices look quite attractive.

If investors are not willing to take the risk of interest rates rising further with rising federal spending and deficits, leaving 10-year bonds vulnerable to losses if sold early, stocks are even more attractive as compared to shorter term maturities. For example, the 3-years rate Treasury is paying only 0.33 percent.  

More importantly corporate profits are poised to surge.

The economic recovery is expected to drive up corporate profits by 52 percent in the second quarter. That would lower the S&P 500 price-earnings ratio to 26—right in line with historical experience.

Seen in that light, stock prices merely reflect close-in expected gains in corporate profits from robust second quarter growth.

Looking out further, corporate profits are expected to continue surging in the third quarter. All that should support a summer rally—if we don’t get a big spring rally instead.

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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

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