S&P 500 has been overvalued for 20 years

Discussion in 'Economics' started by Ghost of Cutten, Oct 9, 2010.

  1. If you take today's S&P as fairly valued, which may in fact be over-optimistic, then you can work out the past fair value of the index, based on a given assumed return for stocks.

    For example, let's say stocks are expected to return their long-term average of 10% per annum. You can go back to a point in time, then work out the index level that would have compounded at a total of 10% per annum, to get to today's price in late 2010.

    Based on this calculation, every year since 1990 would have returned less than 10% from that point up to 2010 for stocks, including reinvested dividends. Every year since then, the index level was above the level that would have been needed to see a 10% return. The only times they were fair value or less were late 2008-2009, and 1990.

    It's also interesting to see the degree of overvaluation. In 2000 at the top, the S&P fair value was around 500, the actual price went slightly over 1500, so it was 200% overvalued. This is pretty much what the bears said at the time, and they were exactly right. All the bull arguments were totally wrong.

    The Nikkei is even worse, it has been overvalued for 3 decades.

    So much for efficient markets and stocks for the long run. Valuation matters.
  2. bone

    bone ET Sponsor

    Well, then did you short the thing at 9,000 a few months ago and live to tell about it - because it is clearly 'overvalued'? 'Course not. Things are worth what people are willing to pay for them. Traders get paid on price, and my opinion is worthless if it is in compete disagreement with the rest of the world's viewpoint on the price.
  3. There is a problem with this line of thinking. Valuation depends on the market's expected future value based on what you know without foresight which is unobservable. Today's actual value includes lots of surprises, and is not really a good approximation for the expected future values at all these points in the past.

    There is a common view that historical realized US equity returns over much of the last century are based on upside surprises and over-estimate expected returns. I think the opposite might be true today, current intrinsic values are lower than what the market expected 5 years ago.

    Smiley faces and puppy dogs, or whaterver you are supposed to put at the end of a message to disagree nicely - I often like your posts.