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No, stocks aren't cheap just yet

Even after a brutal few days for markets, stocks don't look to be cheap. But on the other hand, it's not as if the market is in a bubble.

A peek at the S&P 500's valuation shows that the markets are trading in line with recent average valuations. The S&P's current price is about 15.8 times the earnings analysts expect to see from S&P 500 companies over the next year, according to FactSet. This is exactly in line with the average forward price-to-earnings multiple going back to the beginning of 2000, and a bit lower from the average multiple seen over the past two years.

There are about as many ways to gauge where stocks are going as there are investors. But at the most basic level, a stock is simply an ownership stake in a company, which gives the owner of that stock residual rights to some of that company's profits. This is why determining whether a stock is expensive or cheap often comes down to assessing how much that company is likely to earn, and then seeing how many times that number investors are being asked to pay.

Using consensus analyst estimates is a way of allowing the experts do that difficult first part for you. A forward P/E metric simply takes that number and compares it to the current price. And the same may be done with an index, by aggregating and weighting earnings estimates and using the index price.

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While valuations are probably useless in determining where stocks will go in the short run, they are often used to make long-term predictions. High valuations have been used as a sign that stocks are too high, and low valuations can indicate that stocks will perform well over the long term.

For instance, a forward P/E ratio of 26.5 was seen in March 2000, just before the dead top of the market. And that number got down below 9 in November 2008, which in hindsight was a golden opportunity to buy stocks.

Those who reacted to rising valuations early in the run-up to the tech bubble, or early in 2008 when valuations first began to drop, would have suffered severe pain, at least in the short term. So while the P/E ratio should probably inform long-term decisions, it's no crystal ball.

Even if it was, it's not exactly flashing a screaming "buy" signal now.

"Certainly stocks have become quite a bit cheaper, but I don't think they're all the way to cheap yet," Max Wolff of Manhattan Venture Partners said Wednesday in a CNBC "Trading Nation" segment. "There's a little more negative momentum to come, in our opinion."

The other issue is that analysts might find themselves cutting earnings estimates, which could cause P/E multiples to rise even if stocks stay flat.

All in all, between a further drop in multiples and cuts in earnings estimates, Wolff predicts that "we're about half the way to a resettlement, which was overdue, to be expected, and part of the normal rotation."


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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Brian Sullivan

Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

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