Irrational Exuberance? US Stock Market Valuations Look Stretched vs History

It has been a very good year, and indeed a very good decade, to be invested in the US stock market. The S&P 500 Index is up 23% in the year-to-date, and it’s more than tripled in the last 10 years. But Goldman Sachs doesn’t think the next 10 will be anything nearly as good, with the firm’s chief US equity strategist, David Kostin, writing in a note out Friday: "We estimate the S&P 500 will deliver an annualized nominal total return of 3% during the next 10 years..."

At the heart of the matter is the market’s valuation. Goldman’s researchers get some help from Nobel laureate Robert Shiller, who created the Cyclically-Adjusted Price-to-Earnings Ratio (CAPE). A simple price-to-earnings ratio compares how much one share costs with how much it earns. A share that costs $100 and earns $5 a year has a P/E of 20x. It’s a rough but simple way to compare valuations.

Since 1940, the CAPE has averaged about 22x. So, where are we today? Plugging the latest close of the S&P 500 into a brilliant spreadsheet from Robert Shiller gives us: 40x!

See the full article here.