Business & Investment

The Bulls are once again investing in valuations that test their view of the market.

Stock market bulls are guilty of a sleight of hand when they claim that price-earnings ratios in the US market are not above average. He points out that this is not due to the plunge in the stock market on the first trading day of 2021, but the average of 30 Dow Jones Industrial Averages.
+ 0.18%

At some point, more than 700 points, or more than 2%, fell, S & P 500
+ 0.55%

It decreased by 2.4%.

Instead, it refers to the sleight of hand peculiar to the following statement that the recent Bulls are repeating. ad nauseam Somehow: “Based on analysts’ estimates, the EPS for the S & P 500 in 2021 will be $ 150. Based on market conditions on the last trading day of 2020, this corresponds to a PE ratio of 25.0 It is slightly lower than the average PE ratio of 25.6 over the last 20 years, so the market is well valued or slightly undervalued. “

Note that the historical comparison of this sentence is between apples and oranges. The average PE in the past is calculated based on the EPS for the last 12 months, but the 2021 estimate is based on analysts’ forecasts for next year. The true comparison of Apples to Apples is to compare future-looking PE averages over the past few years.

If this seems confusing, let’s go back to the beginning of 2020 and explain. Standard & Poor’s at the time estimated that the EPS for the S & P 500 in 2020 would be $ 161.87, resulting in a future PE of 20. .. In fact, as we now know, the EPS for the year was much lower. The final numbers haven’t come out yet, but S & P’s best estimate is a total of $ 95. If analysts had accurately predicted this total a year ago, the future-looking PE at that time was 34.

Therefore, the positive PE a year ago was more than 40% lower than the actual result.

Of course, 2020 is a special year and the analyst community is usually not too far away. However, future-looking PEs are almost always much lower than subsequent PEs. Cliff Asness, co-founder of AQR Capital Management, At some point, they were estimated to be 25% lower,on average. One of the reasons for this is that EPS grows in normal years. Second, analysts are almost always too optimistic. For both reasons, revenue, the denominator of the forward-looking PE ratio, is misleadingly high. This means that the ratio itself is misleadingly low.

Conclusion: The historical average needs to be revised down significantly before comparing the future PE ratio of today with the historical average of subsequent PEs. By doing so, you will find that the stock market is significantly overvalued.

Another approach to reach the same conclusion is to consistently focus on 12-month PE tracking. The current trailing PE of the S & P 500 is 39.5, well above the 20-year average of 25.6.

You don’t have to take a stand on whether forward PE or trailing PE is the better gauge of market valuation. The broader point is that we need to be consistent. You can only conclude that the current price-earnings ratio of the stock market is well above average.

Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a flat rate to be audited.He can reach at

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The Bulls are once again investing in valuations that test their view of the market. The Bulls are once again investing in valuations that test their view of the market.

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