This shows U.S. stocks most expensive since WWII

Published Fri, Jan 9 201510:02 AM EST

U.S. stocks are trading at their highest level relative to earnings since WWII, according to one measure that comes from Jim Paulsen of Wells Capital Management. The median price-earnings ratio of stocks on the New York Stock Exchange is slightly higher than 20 times, more than the readings around 19 hit during bull markets in 2005, 1998 and 1962, according to Paulsen's note to clients Thursday. Source: Wells Capital Management, Professor Kenneth French "Today's valuation extreme is not limited only to a subset of stock market sectors but rather, is very widespread," wrote the chief investment strategist in the note. "A concentrated valuation extreme tends to loudly announce itself whereas a broad-based valuation extreme seems more stealth and, therefore, perhaps more dangerous." What's more, the median U.S. stock is priced at a record high relative to cash flow as well. And the price-to-book ratio was higher only two other times, according to Paulsen. The traditional way of measuring the market's valuation has been to look at the S & P 500's market-weighted multiple, which stands today at 18. This is higher than 74 percent of the time since 1945, according to Wells Capital, but still far below levels of 20 to 30 reached during past bubbles. Read More New York Trader: Stock bounce not credible, own yield Paulsen's point is that looking at the median P/E makes just as much sense as looking at a multiple weighted by companies' market values. In fact, it may make even more sense because then one sector, such as technology during the late 1990s, can't distort the valuation of the whole market, he said. "Because valuation dispersion is relatively low today, there are not many areas to hide from overvaluation,"he said in the report. "In 1973 or 2000, investors could reduce extraordinary valuation risk by simply diversifying away from the Nifty Fifty or new era tech stocks. Today, because values are both high and tight, lessening valuation risk may not be possible except by allocating away from U.S. stocks." And history is on Paulsen's side. The stock market entered a bear market or at least had a correction every time except once when the median NYSE P/E was as high as it is now. (In 2005, the median multiple hit 19 and the stock market didn't enter a bear market until 2008.) Read More Chicago trader: Profit from lower bond yields If 2015 does spell the end of the bull market, it certainly wouldn't be a surprise given historical context. With a 200-percent plus gain over more than 2,100 days, this bull ranks as the fourth most powerful and fourth longest since WWII. At the start of this bull market in 2009, the median NYSE P/E was 12 times trailing 12-month earnings. Paulsen isn't alone. Other strategists are sounding the alarm. "I'm amazed at how nonchalant so many are that the end of a $1 trillion QE stimulus program going to zero,"said Peter Boockvar, chief market analyst with The Lindsey Group. "Therefore I believe that excessive valuations in 2015 will all of a sudden matter." "Looking at other measures,such as the Shiller CAPE, Tobin Q, and stock market capitalization as a percentage of GDP, they corroborate mostly the same thing," said Mark Lushchini, Chief Investment Strategist at Janney Montgomery Scott. Boockvar's point about the Federal Reserve is being used by both the bears and the bulls in this valuation argument. The bulls say that valuations are low and can get much richer because P/E's relative to such low interest rates are not at historic highs. Multiples and interest rates (and inflation) do have a long-time relationship. Historically, the data shows that the S & P 500's P/E could be much higher under low interest rate regimes than high interest rate times, before a selloff would occur. "Let's keep in mind the 10-year is only slightly higher than the dividend yield in the S & P 500 ," said Brian Stutland of Stutland Equities. "Tax adjusted, they are almost equal. So,with growth in U.S, do you want to own bonds or stocks? I like stocks." The yield on the 10-year traded as low as 1.91 percent on Tuesday. The dividend yield for the S & P 500 SPDR ETF stands at 1.86 percent. But the bears say this time is different because rates are not just low—they're at zero. And so even a slight increase in rates on the part of the Fed could expose stocks as overvalued and trigger a bear market, they argue. Read More Scared? Here are top correction protection plays Wells' does describe one alternative conclusion, but it still won't make investors who are long happy. "Until the extreme valuation character of the median U.S. stock improves, the stock market may simply struggle to make consistent gains," he said. "This could, of course, be resolved by a correction or a bear market. Alternatively, simply a flattish stock market this year while earnings continue to rise may be enough to refresh median P/E valuations for 2016."

Jim Paulsen

Adam Jeffery | CNBC

U.S. stocks are trading at their highest level relative to earnings since WWII, according to one measure that comes from Jim Paulsen of Wells Capital Management.

The median price-earnings ratio of stocks on the New York Stock Exchange is slightly higher than 20 times, more than the readings around 19 hit during bull markets in 2005, 1998 and 1962, according to Paulsen's note to clients Thursday.