It is hard to find a “talking head” in the media that isn’t able to justify the persistent rally in the major indexes and more recently the Dow Industrial Average crossing 25,000. In short, they are always able to offer that the end is justified by the means. With the end being Dow 25,295 as of Friday, Jan. 5, the means or explanation has been the potential readjusted earnings outlook higher. But who cares about the Dow Industrial Average anymore right? I’d certainly concede to the inherent sentiment displayed for what equates to 30 equities, but it doesn’t mean there isn’t a broader sentiment similarly displayed for equities within the S&P 500 index.
The S&P 500 is currently expressing lofty valuation levels as well or along similar lines to that of the Dow Industrial average. By no means is an S&P 500 PE of 26.36 as of Jan. 5 the most extreme valuation in history, but it is an outsized valuation historically. As it were with our brief narrative on the Dow Industrial Average, there is a rationale to support the seemingly expensive S&P 500 valuation. Regardless of what measuring stick one uses,the markets are decisively overvalued. The key word in that sentence is overvalued and I’m about to offer a complete contradiction to that statement which is lacking context. The context for investors that is of greatest consideration is and will likely always be yield.
Investors don’t seek out lesser yielding investment opportunities; they seek out greater investment opportunities, which carry with them the greatest or greater yield. It’s the very reason equities would still be considered richly valued if one shaves 2,3, or even 4 percentage points off of the S&P 500 PE ratio. Yield is what investors seek and it simply can’t be found in greater quantity than the equity markets today and in recent years. The S&P 500 is currently yielding above 5 percent. The treasury market, well, go ahead and double the 10-year T-bill and what does that get you? As I wrote in my previous research report to Finom Group clients titled Markets Can Trend Higher in 2018, Can’t They?, markets can trend higher in 2018 and they certainly have to date. Moreover, long-term investing is and/or should include a level of risk management. With the current S&P 500 PE ratio above 26 and 14 months without a pullback of even 3% it is still very prudent to exercise reasonable risk management. And if you think I couldn’t be any more verbose, contradictory and long-winded, just keep reading.
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