Is the stock market overvalued at current levels? A lot of analysts think so. On the other hand, there are analysts who think the market has room to move higher. For both sides, a lot depends on what's going on in Washington, D.C.
Since Donald Trump was elected president, the S&P 500 has gained more than 14 percent. Some say it's the Trump bump, the belief that big tax cuts and deregulation in the future will boost company profits. But some are skeptical that Trump can deliver and think the market is overvalued.
The stock market is overvalued by conventional measures. On average, what investors have to pay for a company's stock compared to what that company is expected to earn in profit, that metric has only been higher twice before – before the Great Depression and before the tech bubble burst in 1999. So these aren't exactly uncharted waters per se.
Rebecca Patterson, chief investment officer at Bessemer Trust, an advisory firm for wealthy families, looks at the inflated price of the market and sees the rally coming to an end, especially if Trump and Congress don't cut regulations or reform the tax code like promised.
“What's another good water analogy - choppy waters, deep waters, boiling waters…If the reality, the actual policy that goes through, disappoints expectations, equity markets will be vulnerable, especially given the current valuations.”
A problem with using historical metrics to judge current value is that they don't account for the near record low interest rates we have. Jonathan Golub, with the investment bank RBC Capital Markets, says an overvalued S&P is justified because the chance for recession right now is slim to none.
“Are we creating jobs every month – yes. Are we selling more houses every month – yes. Is inflation picking up – yes.”
Also, banks are loaning more money. Manufacturers see more sales. CFOs are planning big capital projects. Golub says policymakers and the media are causing temporary swings in parts of the market. But in the end, it's just noise.
“As a matter of fact, if you took a basket or a list of the companies that would benefit the most from Trump's tax policy or the most from Trump's America First policy, and then you look at how they're doing compared to the overall stock market at large, they're basically exactly the same,” Golub says.
Barring something out of the blue, Golub says stock prices should go higher once policy details are clear. Citigroup's Tobias Levkovich agrees. He recently surveyed institutional investors and found most are not buying on policy promises yet. And he says 45 percent don't expect major GOP accomplishments until 2018.
“Less than 30 percent thought it would happen in the second half of '17. Nobody's expecting it to happen tomorrow,” Levkovich says.
What's surprising about these current market highs is that since January, most stocks have not risen in value. According to a recent study by Fundstrat Global Advisors, it's only the top 40 companies that have rallied. The other 460 companies in the S&P 500 are essentially flat for the year.
Eric Marshall, portfolio manager for Hodges Capital Management, says, “As a whole, we see this is as very much a bifurcated market in which some areas of the market are relatively expensive while others are not.”
He says at the end of the day, what investors care about are the earnings and cash flow of the businesses they own stock in. He does expect those to improve but not for another couple of years.
