David Rosenberg of the Toronto-based money manager Gluskin Sheff is out with a note today that measures the U.S. stock market as 35% overvalued based on Shiller P/E ratios. His conclusions are largely consistent with commentary Jeremy Grantham gave in an interview with the FT this past Monday.
Rosenberg writes:
According to the Shiller P/E ratio, the S&P 500 is now 35% overvalued — a full one standard deviation event.
The April data was just updated and showed the inflation-adjusted normalized P/E, premised on “bird-in-the-hand” (as opposed to consensus earnings forecasts, which is historically more than 20% higher than we actually get — one reason why Wall Street banks are dubbed “the sell side”) 10-year trailing profits, expanded to over 22x from 21x in March.
This is not nosebleed territory, but it is expensive; the historical average is 16.4x. So, this implies that the market is currently 34.7% overvalued benchmarked against the historical norm. It would be nice to say that a higher-than-normal P/E is justified by low inflation and low interest rates. But frankly, real bond yields are not that far from their long-run averages; however, equity valuation is, and something is going to give at some point.
Valuation metrics are not meant to be timing devices. Assets, securities, and currencies can stay overvalued for extended periods of time, but inevitably Bob Farrell’s rule number one on the concept of “mean reversion” will come into play. The operative strategy is to buy low and sell high, not the opposite; and to be paid to take on risk as opposed to be paying for taking on the risk.
Defensive income-oriented strategies, at this point, make perfect sense from our lens.
In my article highlighting Grantham’s FT interview (see my post Jeremy Grantham on Bubbles), I mentioned two standard deviations as a classic bubble rule of thumb. So, while the US stock market is certainly grossly overvalued, it is not a bubble… yet. For his part, Grantham sees European stocks as less overvalued. He also believes that boring lower beta franchise companies like Coca-Cola and Microsoft are well-positioned in this market. Grantham says they are being shunned by investors who now seem to be seeking the riskiest investments and that this represents a buying opportunity.