The “everything bubble” of 2021 has finally deflated after an increase in interest rates led to losses in both the bond and stock markets. While bonds have reached “fair value” territory after a 50% crash, stocks are still considered overvalued, according to a recent note from Ned Davis Research. Although stocks aren’t as overvalued as they were two years ago during the SPACs, NFTs, and meme-stock frenzy, they are still priced at levels that suggest future returns may be disappointing for investors.
The bear market of 2022, which caused a more than 20% decline in the S&P 500, helped bring down valuations. Last week, the S&P 500 entered correction territory. However, NDR remains unconvinced that stocks currently offer a good deal for investors. According to Ned Davis, the market was very overvalued in 2021 and while it is less so now, it is still in the overvalued zone where stocks have historically performed poorly. Various valuation metrics support this view.
One metric that indicates overvaluation is the stock market’s outperformance compared to the growth in money supply, as measured by the M2 gauge. Another metric, the price-to-earnings ratio of the S&P 500 using five-year earnings, also shows that stocks are still overvalued. Davis emphasizes that these charts, going back to the 1920s, continue to demonstrate a bubble in stocks.
Furthermore, when compared to the significant returns offered by bonds, the stock market also appears overvalued. Davis notes that while stocks are not as overvalued on an absolute basis compared to 2021, they are more overvalued relative to bond yields.
Additionally, US households are still heavily invested in stocks, with nearly 40% owning stocks, well above the long-term average of 27%. In contrast, their allocations in real estate, bonds, and cash are underweight, with cash being particularly underweight compared to historical norms. These readings suggest that if US households become disillusioned with their exposure to equities and decide to reallocate their investments, stocks could face significant losses, leaving room for valuations to decline further.
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