State of the Stock Market – Over or Undervalued?

Since the post-pandemic stock market boom, analysts and experts have warned us that the market was overvalued. Some have gone even further and submitted that we’re in a bubble that is set to burst. However, prices keep rising, suggesting many investors believe there is still value to be found. So which is it? Is the market over or undervalued?

The Case for an Undervalued Market

While the S&P 500 has hit record values since the stock market dropped during the early stages of the coronavirus, the FTSE 100 has yet to recover fully. The drop of around 14% left a long way back at the time; however, values have steadily increased by about 5%.

A successful vaccine rollout and an easing of Brexit anxiety have made a big difference. In fact, for the first time in five years, investors are equal weight on the market.

However, despite all of this, the market remains at a significant discount. According to the broker Peel Hunt, the 12-month forward P/E is 25% cheaper than the eurozone and 40% cheaper than the US markets. So, all things being equal, it seems like Brexit economic fears still exist.

The case for the US stock market being undervalued may be more challenging to make, primarily because it keeps hitting all-time highs. However, some analysts believe bad maths and mistaken presumptions are behind the doomsday predictions.

In fact, John S. Tobey writes in Forbes that instead of using the P/E ratio, we should use the Earning/yield (E/P) to value stocks. He firmly believes that if we make this adjustment, the market is undervalued.

The Case for an Overvalued Market

As always, there are plenty of voices who believe the market is overvalued. Additionally, two reliable measures of the market suggest the market is overvalued.

The Shiller P/E Ratio stands as 38 times. This number is close to the peak of 44 that it hit during the stock market boom. Strategists at SunDial Capital Research have said that historically a number over 25 is a precursor to significant market corrections. However, they have stopped short of issuing sell warnings.

The second valuation metric that is giving out warnings is the “Buffett Indicator”, which takes the Wilshire 5000 Index and divides it by annual GDP. It currently stands at 238%. To put it in context, the value was at 159.2% before the dot com bubble burst. However, it’s worth noting that this time might be different because interest rates are at historic lows.

Conclusion

It isn’t easy to draw any concrete conclusions about the market right now. In ways, it has been defying all predictions since the covid bounce back. While there are some fears about the delta variant, the successful vaccine rollout has meant a return to some form of normalcy.

Low bond yields and good earning reports have kept money flowing into the markets. If tourism and travel fully return, expect this to continue for some time yet.

Alpesh Patel OBE

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