Stocktake: Just how expensive are US stocks?

No one thinks US stocks are cheap. But how expensive are they?

The question is unavoidable, given the S&P 500 has doubled since March 2020 and now trades on a Cape (cyclically-adjusted price-earnings) ratio of 38. That’s near 1999’s record Cape ratio (44) and more than twice its historical average.

The Cape has its critics, so what about other other valuation metrics? Ritholtz Wealth Management's Ben Carlson points to JPMorgan's latest quarterly Guide to the Markets, which examines valuations relative to their 25-year average. Five of six different valuation metrics suggest stocks look between 29 and 46 per cent more expensive than their 25-year average.

The 10 most valuable stocks look especially elevated, trading on 29.5 times estimated earnings – more than 50 per cent more expensive than usual. However, Carlson points out that the top 10, which mostly consist of mega-cap tech stocks, are expensive for a reason, contributing 34 per cent of S&P 500 earnings over the last year.

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Furthermore, the index looks less pricey when you exclude the top 10 stocks – the other 490 companies are only 19 per cent more expensive than usual.

Yes, stocks are expensive, says Carlson, but there are good reasons for the current overvaluation. Long-term returns may disappoint but another market crash is not inevitable.