“It’s the kind of speculative froth you get at the top of a cycle where valuation loses any anchor in the real world and in earnings and in the prospects of the economy,” says David Stockman, former director of the Office of Management and Budget, in this Bloomberg interview.
The markets “have a hissy fit if the chairman of the Fed even suggested they might begin to taper four years into a recovery,” he says in the same interview.
Those are strong words, and set the impression that equity valuations are totally out of whack. “Of course it’s a bubble,” says Stockman.
What do price (valuation) metrics say?
Citi Research analysts Tobias Levkovich, Lorraine Schmitt and Christina Wood point to a somewhat deteriorating set of metrics in their P.U.L.S.E. review of US equities for December 13. ‘PULSE’ is the acronym for Price, Unanticipated, Liquidity, Sentiment and Earnings.
“Our earnings yield gap is now 0.54 standard deviations above the rolling mean, suggesting that equity valuations are modestly overvalued based on this metric,” say the Citi analysts, referring to the chart below.
Market valuation perspectives
Here are a few more valuation metrics for perspective:
- Trailing Price/Earnings Ratio (based on four-quarter S&P 500 (INDEXSP:.INX) operating EPS) = 16.42. Note that at this P/E range the median expectation (as per history from 1940) for returns over the next 12 months is 9.1%.
- Price/Sales ratio = 1.59x. The average of this ratio since 1985 is 1.29x.
- Price/Book ratio = 2.57x. The average since 1985 is 2.80x.
- Price to EBITDA = 7.98x. Average since 1985 is 7.41x.
- Dividend yield = 2.04%
“Stock buyback activity has stepped up and money has begun to flow into equity funds. With a 1,900 S&P 500 (INDEXSP:.INX) target by year-end 2014 as economic conditions improve next year, we remain generally constructive longer term while continuing to advise nearer term tactical caution,” say the Citi research team.
Here are Citi’s projections for the S&P 500 (INDEXSP:.INX) and Dow Jones Industrial Average 2 Minute (INDEXDJX:.DJI):
