Arguments the stock market is "overvalued" are pretty common these days. But MarketWatch columnist Brett Arends raised eyebrows in a recent column in which he argues "valuations are higher today than they were at the peak in 1999-2000."
The dot.com era was notable for its excesses, he says, but the heady valuations of the tech bubble were driven by a handful of uber-high flying stocks, including Microsoft, Cisco, Intel and our corporate parent Yahoo.
"But that overvaluation was quite concentrated in a relatively small number of large-cap growth stocks," Arends recalls. "When you look beyond that small segment of the market, the rest of the market wasn't so bad. That is not the case right now."
Indeed, the median valuation for the top 1500 stocks by market cap today is higher than it was in 1999, Arends reports, citing the following:
- Median P/E today is 20 vs. 16 in January 2000
- Median price-to-book today is 2.5 vs. 2.2 in 2000
- Median price-to-revenue today is 1.8 vs. 1.4 in 2000
"We don't have the wacko, off the charts overvaluation of the dot.com sector in 1999...but we don't have the broad value as well," he says. "Everything seems expensive. There's almost nowhere to hide. It's very difficult to find [value]" in the market today."
A few caveats here:
By his own admission, Arends says overvaluation is not a timing tool. "It does certainly imply the long-term returns to U.S. stocks from here are probably not going to be great," he says. "But they could go up a long way before they go back down. The actual path you take forward can be almost anything."
At 15.1, the S&P 500's forward P/E ratio is lower today than at the start of 2006 (when the S&P rose 14%) or 2003 (26%), The WSJ notes this morning. But earnings today are at record levels as a share of GDP and "these have typically mean reverted," Arends responds. "If you think earnings are going to grow faster than the economy" -- S&P 500 earnings are on track to rise 8.4% in the second quarter vs. 4% for GDP -- "then they have to become an even larger share of GDP."
Dividend yields today are more attractive than in January 2000 at 1.3% vs. 0.8%. As I note in the accompanying video, this is a major factor working in the stock market's favor, given the low levels of Treasury yields, with the 10-year at 2.4% currently vs. 6.66% in January 2000. The earnings yields of the S&P 500 is currently 6.8% vs. under 2.5% in January 2000.
Arends is unmoved by this argument. "If you're saying stocks are overvalued but so is everything else, I'd agree with you," he quips. "I would love to be bullish...but I find the bearish case on stocks is stronger than the bullish case."
Certainly he's not alone in that view, especially when it comes to long-term equity returns. But in the short term, the bulls seem to have reasserted themselves; the S&P 500 was recently up 0.5% at 1941, continuing a rally that began Friday morning.
As I wrote Friday, the onus remains on the bears to show that recent weakness is the beginning of the end of the bull market, rather than yet another buying opportunity.
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- Brett Arends