Is the S&P 500 Cheap?


The S&P 500 has soared 14.5% since the start of the year. Are equity valuations stretched?

On May 17, Factset wrote:

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"The forward 12-month P/E ratio for the S&P 500 now stands at 14.4, based on yesterday's closing price (1650.47) and forward 12-month EPS estimate ($114.94). This is the highest forward 12-month P/E ratio logged by the S&P 500 in more than three years (April 2010). Given the high values driving the P in the P/E ratio, how does this 14.4 P/E ratio compare to historical averages? Is the index now overvalued? On the one hand, the index is now trading above both the 5-year (12.9) and 10-year average P/E ratios. On the other hand, it is still trading below the 15-year average P/E ratio (16.5), and is not close to the peak P/E ratio of 25 recorded in the late 1990's and early 2000's."

Another measure of valuations (arguably stricter and more robust) is the PE10, also known as the Shiller P/E.

Currently, the S&P 500's PE10 is at 24.8, (see chart) which puts it above its historical median of 15.89, but still below its 1999 peak of 44.20.

The PE10 is calculated by accounting for yearly earnings of the S&P 500 for each of the past ten years and adjusting them for inflation using the Consumer Price Index (CPI). On a year-to-date basis, the S&P's top performing industry sectors are healthcare (NYSEARCA:XLV) ahead by 19.89%, and the two consumer sectors;  staples (NYSEARCA:XLP) up by 15.95% and discretionary (NYSEARCA:XLY) up by 18.48%.

Since bottoming in March 2009, the S&P 500 (NYSEARCA:SPY) is up more than 119% 

While the broader stock market may ignore valuations, the first sign of any significant mean reversion will be reflected in a technical break below key price levels. Remember: Valuations are important, but prices are a leading indicator.   

The ETF Profit Strategy Newsletter and Technical Forecast tracks market valuations along with major support and resistance levels for the S&P 500, plus other key asset classes like bonds, gold, and the euro. Our no bull approach is world famous.