Is the U.S. Stock Market Overpriced?
The current U.S. stock market is expensive, with some observers going as far as saying that it’s overpriced.
Investors engaged in the market, or anyone considering buying stocks soon, should consider the situation. Overpriced stocks can suggest that the market will eventually enter a downturn which could devalue any investments made today. What’s the best way to gauge the health of the market?
Using the S&P 500 Index as a benchmark, let’s see if the U.S. stock market is overpriced…
Using the P/E Ratio to Determine Stock Market Health
The P/E or Price to Expense ratio is one of the most important metrics used to measure stock market health. The S&P 500 Index currently has a trailing P/E ratio (an average of the previous twelve months) of $30.23.
This means that investors are paying as much as $30, on average, for every $1 of corporate earnings. For many, it would seem a hefty price for investing in stocks, but this is a bull market.
In a bull market, investors are generally optimistic that prices will increase. That optimism alone can drive prices upwards. This is what we have seen recently with record highs across all major indexes. The S&P 500 has an implied earnings growth rate of 31.04% for the next year, suggesting that the index will expand, keeping the bull market alive.
Corporate earnings drive demand for stocks. If publicly traded companies continue to grow, then the market’s momentum should be maintained.
What’s Driving the Stock Market Today?
Besides corporate earnings, other factors are driving investor confidence.
- The Coronavirus Pandemic is ongoing, but it is being managed better than it was a year ago. Widespread shutdowns are now easing and some of the most affected states, including New York, are opening back up for business. Fewer economic restrictions from the Coronavirus should help to support corporate growth in the coming months. An increase in the speed of vaccine rollouts nationwide has also contributed to investor confidence.
- America’s economy is recovering from the Pandemic. In the first quarter of 2021, U.S. GDP (Gross Domestic Product) increased at a rate of 6.4% [1]. This compared positively to the final quarter of 2021 where GDP increased by 4.3%. Government stimulus measures through individual payments and initiatives like the Payment Protection Program have had a positive impact.
When considering the strong GDP growth, it could be argued that the stock market isn’t overpriced at all, even though investors are paying record prices for popular growth stocks. However, much of this growth has been spurred by the federal government’s stimulus program to individuals and corporations. If the government economic intervention cease then stock evaluation could take a significant dive.
The Bottom Line: Is the U.S. Stock Market Overpriced?
There’s some subjectivity at play when answering this question. Investors are paying more for stocks today. With earnings growth expected over the next year, movement in the market could be sustained. P/E is higher than its historical average so all investors should have some precautions.