The state of the markets as earnings season begins: are we really overpriced?
Earnings season begins this week in earnest, with reports from Bank of America, IBM and Visa, among others. But there is a growing chorus of voices insisting that the market is topping out. The worries revolve around four main complaints: 1) The bull market is eight years old, few bulls have lasted longer and it is reaching the end of its lifespan, 2) The Fed will have a tougher time than anticipated managing the reduction of its balance sheet and increasing rates, 3) Political developments (lack of progress on tax cuts) are already slowing the advance of the markets and 4) The stock market, particularly technology, is overpriced.
Let's just tackle the idea that the market is somehow overpriced. Stocks are at historic highs because earnings are at historic highs and the global economy is improving. It's that simple.
But is the market overpriced? The most important determinant of stock prices is forward earnings estimates. According to JP Morgan, the forward price/earnings ratio for the S&P 500 is 17.5, which is slightly expensive but well within historic norms. The 20-year average is 16.
Even the complaint that technology stocks are too expensive doesn't ring true — as a group technology stocks are below their historic average P/E. Thee forward P/E is 17.9 versus the 20-year average of 20.8.