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Is the US stock market overvalued?

| August 23, 2016
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recession graphicWe will share with you a brief overview of the markets last month, and answer the question : is the US stock market overvalued?

July marked five consecutive winning months for the S&P500 with a gain of 3.7% for the month – the best July since 2013 and first 5-month win streak in two years. Should stocks rise again in August, one of the seasonally weakest months, it would mark the first six-month winning streak for stocks since early 2013! This performance was surprising considering many reasons for investors to be concerned – Brexit, slow global growth, US election uncertainty, terrorism, and many more…

July was also a good month for international stock markets with both the MSCI EAFE (which is international developed) and MSCI emerging markets indices each with gains of 5.1% for the month. Again, impressive considering the uncertainty surrounding the UK’s eventual exit from the UK – so called Brexit - and ongoing concerns about the health of European banks.

We want to answer the question: is the US stock market overvalued? If you follow any sort of financial media, we’re sure you have heard that the S&P500 is “expensive” or “overvalued” a lot recently. And the answer is it actually depends on which methodology you are using to evaluate. If you look at the S&P500’s price-to-sales ratio (which is found by dividing a company’s market cap by its revenue over the most recent year), it is currently at 1.93times, which on the surface is quite a bit above the 5-year average of just under 1.6times. But as Oppenheimer Funds pointed out in a recent market commentary, the primary issue with market-cap indices (which the S&P500 is) is that they are price-driven, so they give the highest priced stocks the largest weightings, and the lowest priced stocks the smallest. If you were to create a revenue-weighted index (which Oppenheimer has) that takes the same 500 companies but weights them based on trailing 12-month revenue, you would find that this index’s price-to-sales ratio is 0.8times. Admittedly, 0.8times is not necessarily cheap compared to its 5-year average, but it is significantly less overvalued than its market-cap strategy. So remember, next time you hear someone say “The S&P500 is extremely overvalued” ask them “based on what methodology? Because while a market-cap-weighted methodology might be producing an overvalued answer, a revenue-weighted index might tell a completely different story.

Thank you for taking the time to read this, and as always, if you have any questions, please feel free to contact us!


IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.

Investing involves risk including loss of principal.

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The MSCI EAFE Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada.

The MSCI ACWI Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI consists of 46 country indexes comprising 23 developed and 23 emerging market country indexes.

The Barclays Capital Aggregate Bond Index, which used to be called the "Lehman Aggregate Bond Index," is a broad base index, maintained by Barclays Capital, which took over the index business of the now defunct Lehman Brothers, and is often used to represent investment grade bonds being traded in United States.

Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company's profitability. Earnings per share is generally considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings valuation ratio.

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