Even though the major stock market averages are flat for the first six months of the year, by nearly every measure the stock market is still extremely overvalued. This point is not lost on Ms. Yellen and company, as the Fed Chair herself has recently assented that the current value of stocks are “quite high”. Given this, the Fed must privately be afraid that even a small change in the Fed Funds Rate could serve as the needle that pops the massive bubble in the stock market.
Exactly How Overvalued Is This Market?
First, the median Price to Earnings (PE) multiple on New York Stock Exchange (NYSE) equities is currently off the charts. Using this measure, the 2,800 NYSE stocks are at the highest level since records began since 1945.
Adding to this, the cyclically adjusted PE ratio (CAPE) for the S&P 500, which uses real per-share earnings over a 10-year period, is at a current level of 27.17. This is far higher than the long term average of 16.61, and only slightly below the 32.56 level achieved at the start of the Great Depression in 1929.
And then we have the Q ratio: the total price of the market divided by the replacement cost of company’s assets. Historically this measure averages around .68. Today this ratio sits at 1.14, the highest level recorded since the dotcom bubble, and an increase of 100% from its value in 2009. Using this metric, the value of U.S. equities is more than 10% higher than the cost to replace all of the underlying assets.
Finally we have the Total Market Cap to GDP Ratio, which represents the value of all stocks in the Wilshire 5000 divided by total U.S. output. This value indicator, at 125% of GDP, is higher than any other time in history outside of the dot.com era. And is about 75 percentage points greater than it was throughout the period 1975-1995.
As you would expect, Wall Street commentariats argue the current PE ratios are justified given the level of low interest rates. After all, they will find any excuse to keep pushing products to their clients.
