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The Lindsey Report – Is the Market Overvalued?


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There was no Black Friday for domestic equities this October, as the S&P 500 continued setting record high after record high.  Ever since the shenanigans in Washington were quelled (only temporarily), equity markets resumed their climb higher.  The S&P 500 was up approximately 3.5% for the month (Reuters).

The real impetus for the markets move upward is grounded in Washington, but it is much less about the “inaction” of the government and more about the “actions” of the Federal Reserve (Fed).  While many believed the Fed would begin tapering in the 4th quarter that did not happen.  Suffice it to say, their action is significantly contributing to the rise in equity values and the “risk on” trade.

With equities setting new highs, I am often asked a similar question, “is the market overvalued” or “is the market too high”?  That is an especially loaded question, as it is a relative question.  It very much depends upon how you look at it, what matrix(s) you use, your timeframe, your future expectations, etc….   I doubt the S&P 500 is ever “perfectly valued”, so it is likely always either getting ahead of itself or falling behind.

I’m one who believes that earnings should drive valuations and one good measurement is the P/E ratio, which = Price divided by Earnings.  For the S&P 500, it is the index value divided by the trailing, 12-month earnings of the 500 S&P companies.  The current P/E is 19.45.  For reference, the average ratio going back to 1917 is 15.5 (Robert Shiller).  Based upon this measure, I believe domestic, equity values have gotten a bit ahead of themselves and we are somewhat overvalued.  Having said that, equity levels can easily be supported, as long as the economy improves and earnings continue to rise.

Therefore, with the S&P 500 at or near an all-time-high, I see this as an opportunity.  It is an opportunity for those planning to take a distribution from their equity portfolio (maybe for a car, a down payment, a required distribution, a vacation, etc…), to do so at an all-time-high.  If no distributions are planned, this may be an opportunity to re-balance portfolios, as they could easily be “out-of-balance”.

 

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