Advertisement
U.S. markets closed
  • S&P 500

    5,254.35
    +5.86 (+0.11%)
     
  • Dow 30

    39,807.37
    +47.29 (+0.12%)
     
  • Nasdaq

    16,379.46
    -20.06 (-0.12%)
     
  • Russell 2000

    2,124.55
    +10.20 (+0.48%)
     
  • Crude Oil

    83.11
    -0.06 (-0.07%)
     
  • Gold

    2,254.80
    +16.40 (+0.73%)
     
  • Silver

    25.10
    +0.18 (+0.74%)
     
  • EUR/USD

    1.0801
    +0.0008 (+0.08%)
     
  • 10-Yr Bond

    4.2060
    +0.0100 (+0.24%)
     
  • GBP/USD

    1.2634
    +0.0012 (+0.09%)
     
  • USD/JPY

    151.1980
    -0.1740 (-0.11%)
     
  • Bitcoin USD

    70,098.49
    -580.24 (-0.82%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,952.62
    +20.64 (+0.26%)
     
  • Nikkei 225

    40,369.44
    +201.37 (+0.50%)
     

US Market Significantly Overvalued Ahead of Memorial Day Weekend

- By James Li

The U.S. stock market remains significantly overvalued ahead of the Memorial Day weekend. As of May 26, the ratio of the Wilshire 5000 index over the gross national product is 132.2%, which implies an annual return of -1% including dividends.

Buffett indicator reaches 132%


Berkshire Hathaway Inc. (BRK-A)(BRK-B) CEO Warren Buffett (Trades, Portfolio) mentioned that the percentage of total market cap relative to the U.S. gross national product is "probably the best single measure of where valuations stand at any given moment." As illustrated in Figure 1, the total market index reached $25131.7 billion May 26, a new 10-year high.

1495812545264.png
1495812545264.png

Figure 1

Figure 2 summarizes the predicted annual returns based on three scenarios. In the pessimistic case (shown in green), the expected annual return is -8.8%. The most optimistic case (shown in red) gives an expected annual return of 3.9%.

1495813059615.png
1495813059615.png

Figure 2

As discussed in a previous article, Buffett keeps adding to positions with high price-sales (P/S) valuations, including Apple Inc. (AAPL), Bank of New York Mellon Corp. (BK), Southwest Airlines Inc. (LUV) and Delta Air Lines Inc. (DAL). Apple's revenue remains near a 10-year high even though the growth has slowed down during the past 12 months. The Cupertino, California tech giant's share price is about 3.73 times its per-share revenue, ranking lower than 81% of global competitors.

1756123130.png
1756123130.png
1978472068.png
1978472068.png

Shiller P/E about 0.5 away from 30

Yale professor Robert Shiller measures market valuations using the cyclically adjusted price-earnings (CAPE) ratio, which is the price of the Standard & Poor's 500 index over the average inflation-adjusted values for the past 10 years. Figure 3 shows the historical trend of the market Shiller price-earnings (P/E) and the implied return.

1617684666.png
1617684666.png

Figure 3

As illustrated in Figure 3, the S&P 500 has a Shiller P/E of 29.9, which is about 78% higher than the historical median of 16.8. Assuming that the Shiller P/E reverts to the mean, the S&P 500 is expected to return -1.9% per year for the next eight years.

GuruFocus also gives the range of expected returns if the Shiller P/E reverts to 50% to 150% of the historical mean. The expected annual S&P 500 return ranges from -9.6% (if the Shiller P/E reverts to 50% of the mean) to 3.0% (if the Shiller P/E reverts to 150% of the mean).

Some tips to invest in a significantly overvalued market

GuruFocus provides several strategies to invest "defensively," including the Most Broadly Held, Undervalued Predictable and Buffett-Munger strategies. The model portfolios based on these strategies have outperformed the market in at least six of the past seven years. A previous article discussed six high-guru-ownership stocks while a second discussed six potential Buffett-Munger companies.

Premium members have access to the screeners based on the above value strategies: the Aggregated Portfolio of Gurus, the Undervalued Predictable Screener and the Buffett-Munger Screener. You can also generate custom screeners with the All-in-one Guru Screener and backtest the strategy for three years.

Disclosure: The author has no positions in the companies mentioned.

Start a free seven-day trial of Premium Membership to GuruFocus.

This article first appeared on GuruFocus.


Advertisement