The Case for Extreme Overvaluation

This analysis provides insight into the general relationship between aggregate stock valuations and long term returns. The study indicates a strong relationship between real returns and the level of valuation at which an investment is made.

The chart below captures one presentation of the results.

Essentially, the proposition goes like this:

The higher the market P/E ratio when an investment is made, the lower the return over the next decade.

The same thing holds true when dividend yields are low:

The lower the market dividend yield when an investment is made, the lower the return over the next decade.

This analysis suggests that, presently, markets offer little value in aggregate. Currently the S&P 500 sports a ten year normalized P/E of about 27 and dividend yield of 1.8%. Subsequent ten year returns associated with made at these levels have historically averaged about 1% annually or less.

In fact, the case could be made that current markets are extremely overvalued in aggregate.

btw, these findings very closely parallel the work of John Hussman.

position in SPX