Sunday, August 10, 2014

The U.S. Stock Market Is Now More Expensive Than The Bubble Peak In 2000

MarketWatch released an article this week that received some mainstream attention regarding a topic I have focused on throughout the year.

Back at the market peak of what is widely considered the greatest U.S. stock market mania in history (March of 2000), the overvaluation in the market was heavily concentrated in the tech sector. While the overall market was expensive, it was the small tech sub sector that was out of this world expensive.

When you look at the general market today vs. the market in 2000, you find that it is more expensive today than it was at the previous all time mania peak in 2000. Looking at the top 1500 stocks by market value, the median stock today is priced at 20 times earnings while in 2000 it was only 16 times earnings. 

The median stock today trades at 2.5 book value when in 2000 it was just 2.2. The median stock today trades for 1.8 times annual per-share revenue when in 2000 it was just 1.4. 

Here's a simple way to understand this. Imagine back in 2000 you owned 5 stocks with the following P/E ratios (I am just making up the P/E ratios for example purposes):

Coca-Cola - P/E 14
Procter & Gamble - P/E 15
Johnson & Johnson - P/E 16
Chevron: - P/E 18
Microsoft: - P/E 70

Average Price to earnings ratio: 26.6

Today you hold the same stocks with the following P/E ratios:

Coca-Cola - P/E 19
Procter & Gamble - P/E 21
Johnson & Johnson - P/E 23
Chevron: - P/E 24
Microsoft: - P/E 25

Average price to earnings ratio: 22.4

"You see!" shouts your financial adviosr, "the market is less expensive today than it was in 2000!" But is it? The median (middle number) price to earnings ratio has moved from 16 to 23.

If you strip out the insane valuation of Microsoft back in 2000 the overall portfolio is far more overpriced than it was in 2000. This is exactly what is taking place today. Investors are not cramming into one small sector, they are cramming into everything across the board. 

Does this mean the U.S. market has topped and must begin crashing tomorrow? Nope. Markets can go from extremely over priced to more extremely over priced before the laws of gravity return. When the market does decide to mean revert back to its historical norm, you just better hope you were able to exit through the small door in the burning theater before the rest of the crowd.

With the market's ability to flash crash due to high frequency trading, it will be unlikely that everyone will exit the theater alive.

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