What is the value of the stock market is a valid question since I’m about to launch a new portfolio and the value of the stock market has a direct influence on how that portfolio will be comprised.
To cut a long story short if the stock market is overvalued then I’ll purchase more bonds than stocks.
The same goes for when the stock market is cheap: I’ll buy more stocks than bonds (if any).
For the purposes of this post I will assume that you know what the PE Ratio is and how it can help investors with intrinsic valuations of stocks – if not check out the post The PE (Price to Earnings) Ratio.
In a nutshell I need to conclude what the value of the S&P 500 is since I plan to purchase mostly US listed stocks (more on that in another post).
The S&P 500 is a far greater measure of the market value (not intrinsic value) of US stocks that the Dow Jones simply because the S&P 500 has more companies in it’s index and is therefore is more representative of the stock market’s value in theory.
What is The Value Of The S&P 500?
If you do a Google search of ‘PE Ratio S&P 500’ and filter through the results you are left with the clear impression that the most popular way to calculate the PE ratio of the S&P 500 is to divide the value of the S&P 500 by trailing twelve months (TTM) earnings.
From the Investopedia website:
The timeframe of the past 12 months used for reporting financial figures. A company’s trailing 12 months is a representation of its financial performance for a 12-month period, but typically not at its fiscal year end. Since quarterly reports rarely report how the company has done in the past 12 months, TTM tends to be calculated manually or found on various websites.
What this means is that if the S&P 500 is 2063 as of today’s date and the TTM is $94.91 you have:
Therefore the market value of the S&P 500 is 21.74.
Check out multpl.com which has a an updated chart of the PE ratio of the S&P 500 using the TTM method.
There is also a handy table of historical yearly and monthly PE values.
Is The S&P 500 Overvalued?
The short answer is not yet but it’s getting there.
If you look at the chart of the S&P 500’s PE Ratio you’ll notice that between 20 and 25 the market ‘corrected’.
You’ll also notice that this relationship with the 20-25 area as being overvalued has in recent years been replaced with increased volatility in market valuations.
When earnings take a nosedive and the value of the S&P 500 continues to stay at historic highs the ratio becomes very high indeed.
My view is that the S&P 500 is close enough to being overvalued for me to split stocks and bonds on a 40/60 basis:
- 40% stocks
- 60% bonds
This gives me the firepower needed to buy undervalued stocks on an individual basis – the Volkswagen debacle is not the first and will not be the last opportunity presented to investors.
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