Why This Stock Market Isn’t As Overvalued As You Think

silver arrows going up blue bars

It’s a common opinion that the stock market is way overvalued right now. That’s a reasonable conclusion. After all, the S&P 500 is up about 20% just since the beginning of November and has soared a staggering 72% from the low of last March. And we are still in a lockdown-hobbled economy. 

And yet, despite the continuing lockdown restrictions and political acrimony, the market indexes have been making an incessant series of new all-time highs for months now. This market is starting to look like that red-shirted, never-before-seen character on a Star Trek episode that beams down to check out the interesting planet with Kirk and Spock. You just know it’s dead meat.

Investors are anticipating a full recovery later this year, ushered in by the vaccine and the removal of remaining lockdowns and restrictions. On the basis of that uncertain and optimistic outlook, the S&P 500 is currently priced at 32 times the average price to earnings ratio. History indicates that a market this highly-priced has one foot on a severe correction and the other foot on a pile of K-Y Jelly.

But stocks may not be nearly as overvalued as most believe.

The Stock Market isn’t that Overvalued

Sure, a market P/E ratio of 32 is a nose-bleed territory, and it can’t last. But that number is based on trailing earnings, which include a very temporary state of pandemic lockdowns and some of the worst economic quarters in history. A look beyond the past outlier year paints a more accurate picture.

The economy is already roaring back. So far, reported fourth-quarter earnings are averaging 1.7% growth over last year’s pre-pandemic fourth quarter. Companies are already making more money than before this virus nightmare, and the recovery still has one arm tied behind its back. Forward earnings for the S&P 500, based on estimates for the current year, are an average of 22 times, just slightly above the average market valuation of 20 times over the past 30 years.

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