Stocks have now run up about 25% over the past 4 1/2 months. Today I thought I’d just spend a little time looking at valuation to see if stocks are still attractive on an absolute and relative basis. The chart below shows the price to earnings ratio of the S&P 500 based upon the trailing 12-months earnings number:
On this measure stocks are just about in line with their average valuation over the past 100 or so years.
Another way to look at valuation is to use the index’s price compared to peak earnings. This method is a bit smoother because we throw out the big valleys in earnings you get during a recession.
This perspective suggests stocks are slightly overvalued right now. However, we have recently made new all-time highs in the earnings number which is still growing so this ratio may soon change.
Finally, neither of the charts above consider stocks’ relative valuation to bonds. Looking at earnings as a yield compared to the long-term Treasury yield suggests stocks are very cheap on a relative basis:
If interest rates begin to climb, though, stocks relative advantage will diminish. All in all, it looks like investors over the past few months have realized that stocks are the place to be. We’ll keep our eyes open to see how this continues to develop.