- Q1 GDP Growth Jumps 1.1% on Strong Personal Consumption
- A Strong March Leads to a Surge in Chinese GDP in Q1 2023
- Durable Goods Retail Sales Suffer from High Interest Rates and Wary Consumers
- Choppy GDP Means UK Should Avoid Q1 Recession
- Japanese Consumer Confidence Jumps to Highest Level in Over a Year
- The End of Summer Sees the End of Disinflation in Europe
- Labor Market Indicators are Starting to Unify on Easing in Hiring
- Inflation and Tight Financial Conditions Weigh on the German Consumer
- Euro Area Money Supply Contracts for the First Time Since 2010
- Dismal Economic Data Out of Germany
- Core Durable Goods New Orders See Gentle Uptrend in July
- More UK Data Pointing to Q3 Decline
- Whispers of a UK Contraction in Q3
- Japan's Core Inflation Resumes Uptrend in July
- Early July Economic Data Leads to a Sharp Increase in Q3 Growth Expectations
- UK CPI: Energy Inflation Crashes but Services Inflation is Still Sticky
- China's Weak Start to Q3 Means More PBoC Easing
- A Breather for the Eurozone as Inflation Hits Two-Year Low
- Germany's September CPI Report: A Clearer Picture of Inflation Trends
- US Manufacturing Demonstrates Resilience Amidst Volatility in August
- The ECB Prepares to Address Excess Liquidity Through the MRR
- Bank of Japan is Too Optimistic on Inflation
- The Bank of England Pauses in a Near Split Decision
- UK Inflation August Update: A Precursor to the Bank of England's Announcement
- Housing Starts Tumble in August Amid Rising Mortgage Rates
- US Retail Sales Grow at Fastest Monthly Rate Since the Start of the Year
- US Consumer Prices Surge in August Driven by Energy Costs
- August NFIB Survey Showed a Tough Environment for Small Businesses
- All Signs Point to a Weaker Labor Market in August
- Chinese CPI Trying to Buck the Deflation Trend
- Energy Prices Rise but the Core Disinflationary Trend is Maintained in September
- PPI's Quiet Rise and the Energy Elephant in the Room
- Small Businesses Grapple with Inflation and Financial Strain in September
- A Wacky September Jobs Report Shows Strong Labor Market
- A Look at the Fragile US Labor Market Ahead of the Nonfarm Payrolls Report
- Thoughts on GME and This Week in the Stock Market
- Record Home Price Levels Point to Strength in Post-Pandemic Economy
- The Stock Market Looks Overvalued, but It's Probably Not
- China GDP Growth Surpasses Expectations
- President-elect Joe Biden Introduces His "American Rescue Plan"
- Political Polarization Intensifies with Another Impeachment Along Party Lines
- Metal Demand Has a Bright Future in 2021 and Beyond
- What Happened to That US-China Trade Dispute?
- Civil Unrest, A Rising Threat to the 2021 Economy
- What's in the $900 Billion Relief Plan?
The Stock Market Looks Overvalued, but It's Probably Not
January 20, 2021
It's no secret that the stock market, at the surface, is exhibiting bubble-like features. Investors traded through the most troubling year since 2008 dealing with unprecedented events including the first global pandemic since the 1918 Spanish flu. Despite seemingly insurmountable obstacles, the value of the public companies in the United States rose and continue to rise at the beginning of 2021. It was a market reliant on expectations more than ever before driven by headlines that hope and relief were coming in stimulus, the reopening of businesses, and a vaccine. As the economy teeters on the fence between that hope and impending despair, investors search for ways to justify these bubble-like features that typically indicate bearishness.
Moody's Chief Capital Markets Economist John Lonski. points out that "the market value of common stock now approximates a record-high 185% of GDP" in a January 14th report comparing it to the peak of 137% of GDP during the 1999-2000 dot-com bubble in 2000 Q1. The last time it reached comparable heights was 140% in 2018 Q1. The stock market's value compared to corporate profits has elevated as well. At 18.4 to 1, its at its highest level since 2001 Q3 at 18.6 to 1. The growth in this ratio may also be attributed to the economic difficulties brought on by the COVID-19 pandemic.
While these data points point towards high valuations in equities, they may make sense in a bigger picture where bond yields have been held down by low Treasury yields and liquidity provided by the Fed. Lonski notes that long-term Baa industrial company bond yields averaged 8.28% in 2000 Q1 while the most recent average Baa industrial yield was 3.27% (it hasn't been this low since October 1952). Bringing bond yields into the picture makes frames the elevated valuations differently.
Yardeni Research's models showing the Fed Stock Valuation Model actually give evidence supporting an undervalued stock market when using both Treasury yields and corporate bond yields. The idea is encapsulated in the motif that investors are moved by a "search for yield" in whichever asset classes are most available to them. The Kansas City Fed illustrates this concept in a 2000 paper titled "The P/E Ratio and Stock Market Performance."
The visualization is constructed using a comparison of yields in stocks and bonds. The stock yield is represented by an earnings yield which is the inverse of a holistic P/E ratio, and bond yields by the Moody's Baa average corporate bond yield (but can be represented by Treasury yields which are used in the Kansas City Fed paper or other types of fixed income). The higher the spread is, the more stocks are yielding in comparison to bonds. The chart clearly shows that the suppression in bond yields has led to larger spreads since the Great Recession that are very far away from pre-dot-com bubble and pre-financial crisis spreads.
So yes, the market is exhibiting certain bubble-like features that give some investors warning, but in the greater context of the financial markets, those features seem irrelevant. The "search for yield" still seems to point at equities as the most opportunistic asset class in the financial sphere. That doesn't necessarily mean that every company is inexpensive and an opportunity for investors, but it does suggest that general stock market can drift higher from its current level.