How Expensive is the Stock Market?

Are the fundamentals of the business improving in tandem with the increase in the market price? This can be viewed by looking at the trailing twelve month (TTM) earnings. Earnings are cyclical, and companies can look cheap at the top of a cycle where earnings have peaked.
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The multiple drops when earnings fall. Robert Shiller developed another approach: the Cyclically Adjusted price to Earnings ratio. To smooth out the cyclical rises and falls of earnings, this method averages earnings from the last 10 years. This approach has a problem: earnings are increasing over the long-term, and this growth will be delayed by the 10-year average. Data Source: multipl.comCAPE was a good indicator of where you were in the economic cycle up until the 1980s.
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It would fluctuate around the median price ratio (x16); and if you were higher than x20, it was likely that the market was expensive. If CAPE is significantly higher than the TTM multiple, it can indicate tough times for equities (the 1930's great depression, the 1970's stagflation, and the 2000 ".com" bubble). This is why CAPE was stopped in 2000.
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The CAPE ratio has been significantly higher than the TTM ratio from 2005 to 2020. The impact of interest ratesInterest rates have been falling since the 1980s. Because lower interest rates are less favorable for cashflows, this has an impact on the price of equities.
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A dollar tomorrow is worth less today. It can also be thought of as if there is more "easy money", which drives up the cost of assets. Data: Federal Reserve Bank of St. Louis. This plot shows that the stock market was too high in the late 1990s due to earnings and interest rates.
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It also shows the period following the 2008 financial crisis as a great place to buy (CAPE was lower that it should have been, given interest rates). To normalize it, I divided current CAPE by interest-adjusted CPE value. The S&P 500 is about 9% above its fair value, given current interest rates. It was 26% higher than fair value a year back
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Although the recent bear market in 2022 has made it easier to close that gap to fair values, it is not enough. Market Capitalization to Gross Domestic Pro: 'The best single measure to determine where valuations are at any particular moment. Warren BuffettBuffett has since retracted a bit on this statement, pointing out that one simple measure is not sufficient to account for complex markets like the US Stock Market. This ratio can be described as the Price to Sales ratio for the whole country. Market cap is the amount you would pay for all publicly traded businesses. GDP is the total revenue from all businesses within the country. Data Source: Federal Reserve Bank of St
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LouisI made a plot of it using the Wilshire Market Capitalization 5,000 data and GDP data to include as many public corporations as possible. FRED provided both data sets. I also created a normalized chart by dividing the ratio with the median value
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The data doesn't change much, but it does give an indication of how far off the historical median the current data is. This is not consistent with previous analyses of PE ratios. Market Cap/GDP doesn't account for changes in operating margin because it is more similar to a price-to revenue ratio. Market Cap/GDP doesn't take into account higher operating margins.
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Another source provided me with direct TTM margin data. I was astonished to see that operating margins have more then doubled from the mid-'90s (5%->12%). What will their future look like? They could either stay flat or improve slightly. The index includes more large and well-off businesses (GOOGLE, Apple, Meta, etc.).
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It is possible that their respective "moats" allow them to maintain high margins and that more of the total capitalization moves away 'old world/commoditized business with lower margins. This would be very dangerous. This would be very bad. Operating leverage cuts both sides, and if margins fall, the stock market will likely be closer to the 40 to 80% overvaluation that we observed in the initial market cap-to GDP ratios.
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If I had to guess, most margins will remain. Although they may drop in the short-term, as in 2008, I believe they will remain at 6%. It is much closer to a typical PE ratio, as GDP captures revenue tied to both private and public companies.
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It was hard to compile a complete data set. However, I did find a MSNBC article, a 2010 S&P 500 report, and a 2018/2019 Standard & Poor's data point. This might increase the accuracy of the estimate.
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Globalization did not change as much as I thought. This was made easy by normalizing the Market Cap to GDP Earnings as well as the Adjusted international earnings and plotting them together. This plot shows that a value of 1 represents 'fair value'.
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The current price after accounting for international sales is a little higher that previously seen (6.8%). Summary: Using both data for GDP ratios and PE ratios, it appears the stock market may be slightly overvalued (2-9%), however not in the same way we saw during the '.com bubble or the roaring 20s. We can triangulate the market price range relative to fair value by using multiple sources of data. The intrinsic value of a stock market can be compared to the fair value by using multiple sources of data.
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The FED may lower rates to offset this. These and many other factors could have an impact on the market's performance in 2023. This article was meant to take a snap shoot of where we are today, rather than make predictions about where things are headed in the future.If you enjoyed this article, feel free to 'applaud', and you can follow me on Medium or sign up for emails to be notified of more stories like this.medium.datadriveninvestor.commedium.datadriveninvestor.comNote that this article does not provide personal investment advice and I am not a qualified licensed investment advisor
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This information is intended for entertainment and education purposes only. It should not be taken as investment advice.