Many of our clients ask if the stock market is too expensive today. By many measures as shown on the following chart, courtesy of Charles Schwab and The Leuthold Group, it would appear to be the case at first glance. Valuation metrics such as Price to book value, Price to cash flow, Schiller’s CAPE ratio, and current and forward PE ratio, it certainly appears to be expensive in absolute terms in assessing data over the past 30 years. In looking at forward PE ratio for example, the S&P is around 4600 and the S&P is currently projected to earn somewhere around $220 in consensus terms for 2022. 4600 over 220 gives us an approximate forward PE of nearly 21. This number is certainly higher than the 5-year average near 18.3 and the 10-year average about 16.5 (source: FactSet).
However, if we glance down the chart to equity risk premium, in using the 10-year treasury yield, we notice the inexpensiveness of stocks, relative to bonds, broadly speaking, compared to the last 30 years. Risk to the inexpensiveness to stocks compared to bonds in looking at this valuation metric would be a significant and sustainable surge in the 10 year-treasury, which appears unlikely to us in the current environment. We feel that the structural economic and market backdrop will help prevent a persistent and robust interest rate environment, beyond interest rate levels that we’ve experienced over the last several years. For reference, the 10-year treasury had been just shy of 2% pre-COVID and had been at 3.25% as recent as October of 2018.
At Krilogy, our Portfolio Construction Process is built around appropriate levels of risk in conjunction with your goals and tolerance for risk. If you haven’t analyzed your current risk profile in a while, now may be a good time to meet with your advisor to re-assess.