As The Market Keeps Going Up It Gets "More Overvalued"...Not Exactly

 Hardly a day passes without warnings about the US stock market being a "bubble" grossly overvalued etc etc. No doubt that it would be unreasonable to expect the increase of 7.4% for the month of January to continue at a similar pace. In fact it could well be that all if not most of this year's gains have already been earned. And a year of high single digit returns after 21% in 2017 and 12% in 2017 (all numbers for S+P 500) should not disappoint any long term investor.

There is no doubt that the S+P 500 based on trailing earnings is high at 23.3..but that is basically unchanged from a year ago.

But the impact of tax changes, and global growth are forecasted to raise earnings. Biryni associates (cited in the WSJ) sees the S+P 500 based on forward earnings estimates at 18.6. For the Nasdaq they see the P/E dropping from 27,8 to 21.2.

The great research by Yardeni Associates gives a great picture of the increase in earnings expected this year.

Forecasted strong growth in earnings per share:

Translates into little or no increase in valuations.

            Valuations by Sector: Note that even the technology sector shows next to no increase in
             valuations.

Looked at from these perspectives it is pretty clear that the analogy to the "tech/dot.com" bubble of the late 1990s is misplaced. Not only were the valuations during that period much higher than at present it was a period of ipos of companies with no earnings and poor business models. I fact the recent market has been characterized by an extremely small number of ipos.

And the 2007 stock market crash of 31.7% didn't occur simply because the market was high before the crash....something happened...a massive decline in the real estate market and consequently a wipeout in the earnings and equity of financial institutions it only took a bit of time before the financial institutions actually recognized all those bad loans and the drop in earnings and asset values.. Once the earnings and asset adjustments were made at the end of the fourth quarter of 2008 the S+P hit p/e 71 and by the end of the first quarter of 2009 rose to 119.8.

In other words there is noting inherent about new highs for the market to mean that there is a "bubble" and the market is about to crash. The valuations of the market have not risen with the new market highs in fact if earnings come out better than forecasted the opposite may be the case.

Even if earnings estimates are too optimistic there are other factors that should help the total return of the US market. Large portions of the billions in cash being repatriated from abroad will be used for dividends and stock buybacks..a definite positive for stocks. The weak dollar if it continues is a boost in earnings that helps mostly large US multinational corporations. And for the first time in many years there is strong economic growth at the same time across Asia and Europe.

Finally here is what John Bogle calls the "speculative element in stock prices" which is investors bidding up stocks..and valuations. The latter seems quite possible as it seems individual investors and institutions give up on "waiting on the sidelines" and buy stocks...there are definitely signs of this occurring.

There is what John Bogle calls the "speculative element in stock prices" which is investors bidding up stocks..and valuations. The latter seems quite possible as it seems individual investors. It is these short term" investors" just entering the market who are most likely to sell at the point of a price decline accelerating the short term "correction:.

Does all of this mean another year of anything close to last year's returns? Likely not and those that are just entering into the market will likely be disappointed if that is what they are expecting. And yes there could be a "correction" of the market.

Long term investors who have enjoyed the gains in the US market might consider taking some of their profits from the US market to increase weightings in non US stocks. Even thousgh non US markets actually outperformed US markets last year they still carry lower valuations than the US.