U.S. Stocks Are Disastrously Overvalued, by Bill Bonner

If there are any value investors left, US stocks do not currently represent good value. From Bill Bonner at bonnerandpartners.com:

SALTA, ARGENTINA – Today, we write about corporate earnings.

Unless you’re playing the game of “greater fool” – buying in the hope that someone out there is willing to pay a higher price – the only reason to buy a stock is for its earnings.

As a shareholder, you participate in the business’s profits. All else being equal, as earnings rise, so do stock prices.

Weighing Machine

Investors have their moments of darkness and their periods of euphoria.

Over the short term, this changes the “multiple” investors are willing to pay for each dollar of earnings.

When investors expect higher future earnings, price-to-earnings (P/E) ratios rise. When they expect lower earnings ahead, P/E ratios fall.

But when all is said and done, hope and despair give way to the reality of earnings. You pay for a stock. You expect to get some money back.

Over the long run, stock markets rise and fall, more or less… sort of… on earnings.

Billionaire investor Warren Buffett famously described the stock market as a “voting machine” over the short run… and a “weighing machine” over the long run.

Earnings are what investors are putting on the scales.

According to figures from Yale economist Robert Shiller, over the history of the S&P 500, investors have paid an average of $15.65 for each dollar of underlying earnings.

With the S&P 500 trading at 25.4 times earnings, investors today are willing to pay 60% more than the historical average for each buck of earnings.

Fed Model

Is that “too high”?

The so-called Fed model – which compares how much investors are willing to pay for stock market earnings to how much they’re willing to pay for income on long-term government bonds – tells investors not to worry about it.

Because interest rates are so low, it makes sense that stocks should be high. If you have to pay $40 for every dollar of earnings from a government bond, you shouldn’t mind paying $25 for a dollar of corporate earnings.

That’s the theory.

But government bond yields are low because the Fed pushed them down by diktat. This pushed up the amount investors were willing to pay for stocks without any need for increased earnings.

Ultimately, prices are the only reliable measure of what a stock is worth. But they are subject to change without notice.

To continue reading: U.S. Stocks Are Disastrously Overvalued


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