As investors, many of us look at our personal finances or our long-term retirement portfolio in the context of various stocks or funds we own. In this sense, we can sometimes lose the forest through the trees.
By focusing on how individual stocks perform relative to their peers or the broader benchmarks, we can often lose perspective on how inexpensively or dearly the overall stock market trades, at a given moment in time.
Today, the S&P 500, the most widely tracked Stock Exchange in the world, due to its size and highly diversified nature, trades at a very high level. Despite significant uncertainty with respect to how 2020 earnings will shape up, the consensus right now is that this year's earnings for the S&P will come in around $125 compared to around $165 last year.
This implies a current overall S&P valuation of around 25 times earnings, abnormally high when we consider the long-term average. Using forward 2021 earnings, and if 2019 earnings can be replicated next year, this valuation is still roughly 18 times forward earnings which is still higher than normal and not what we'd expect to see in a recessionary environment.
During the bottom of the 2008 financial crisis, for example, we saw the multiple decline to around 10 times earnings, to put these numbers in perspective.
The “TNA” trade (there is no alternative) which assumes there is no other place for investors to put their money due to interest rates at zero has been a key driver of these heightened stock valuations, as have central bank interventions.
Investors ought to be wary of the 10,000-foot view of markets, and should consider this when making personal finance decisions.
Invest wisely, my friends.
