Median price-earnings and price-to-sales ratios are currently higher now than they were near the height of the last two bull markets. Though this may seemingly be a reason for caution, there are underlying factors to consider before making a judgment about their significance.

I ran numbers looking at valuations near the height of the previous two bull markets and at the bottom of two bear markets. Since we are in the sixth year of a bull market, I thought it would be interesting to compare the valuation ratios now to what they were at the peaks of the previous two bull markets. Doing so provides comparisons, but it is important to realize that they are only comparisons. Just because valuations were at a certain level when a previous bull market peaked does not mean the same level implies a peak now. Neither bull nor bear markets come with expiration dates attached.

The median price-earnings ratio for stocks in our Stock Investor Pro database currently is 20.2 (as of May 1, 2015). This compares to 14.3 on February 25, 2000 and 18.4 on September 28, 2007. The median price-to-sales ratio is currently 1.97, versus 1.33 near the end of the tech bubble (February 2000) and 1.69 near the end of the housing bubble (September 2007). The price-to-book ratio is currently 1.97 versus 1.90 and 2.01, respectively.

Median yields are 0.0% for all periods. This is because the majority of companies do not pay and have not paid dividends. When the universe is restricted to dividend-paying stocks, the current median yield is 2.5% versus 3.0% and 2.3% respectively. Keep in mind that yields and valuations are inversely related, with higher yields implying lower valuations and lower yields implying higher valuations. (As a quick aside, there are currently 2,587 stocks with a yield above 0.0%, versus 2,444 at the end of February 2000. In other words, the total number of dividend payers in the U.S. has not changed significantly over the last 15 years.)

One factor cited as playing a role in the higher current valuations is the very accommodative monetary stance by the Federal Reserve and other central banks. The benchmark 10-year Treasury ended last week with a yield of 2.12%. According to data pulled from Yahoo Finance, the benchmark note yielded 6.34% at the end of February 2000 and 4.58% at the end of September 2007. Put another way, borrowing currently remains at historically low levels and lower borrowing costs boost profitability. Cheap money can also spur merger and acquisition activity—and this year has so far been a busy one for deal making—which contributes to higher valuations. It should be noted that even if the 10-year Treasury note’s yield were to jump by a full percentage point, the yield would still be below levels seen throughout most of the last decade. 

Reduced borrowing costs also helps operating profit margins. Median operating margins are currently at 8.3%, versus 3.6% in February 2000 and 4.9% in September 2007. While there is debate about how much more companies can cut costs, I want point out that median gross margins are currently at 41.1% versus 36.6% and 40.8%. Inflation, as opposed to interest rates, more directly impacts gross margins. As long as inflation remains low, it seems likely that gross margins will remain at higher levels (assuming, of course, that companies can exert enough pricing power to pass along the cost increases they do incur).

The big question, of course, is: How long can valuations stay at current levels? Since neither bull nor bear markets come with expiration dates, nobody really knows. Market analysis is good for telling us where we are, but it’s not always good for telling us where we’re going to go over the short term. The danger with acting on information about prevailing valuations (or similar market data) is the possibility of missing out on future potential gains or not getting back into the markets in a timely fashion after a pullback (or a bigger drop) has occurred. For most investors, it far better to embrace the uncertainty than to try and pick the best times to get out and back in.

(A point of interest: I chose to use the median numbers instead of average numbers because the median represents the midpoint of values. For instance, the current median price-earnings ratio for all U.S.-traded stocks in our Stock Investor Pro database is 20.2, meaning half of all stocks trade at or below this number and half trade at or above it. The current average price-earnings ratio is a much higher 34.5. The average is skewed upward by stocks with extraordinarily high price-earnings ratios.)

Table 1. Median Valuations Over Time

Date	P/E (X)	P/B (X)	P/S (X)	Dividend Yield (%)*	Treasury Yield (%)**	Gross Margin (%)	Operating Margin (%)
2/25/2000	14.3	1.90	1.33	3.0	6.34	36.9	3.6
2/28/2003	15.0	1.31	0.88	2.6	3.70	37.0	3.6
9/28/2007	18.4	2.01	1.69	2.3	4.58	40.8	3.8
2/27/2009	10.1	0.82	0.68	4.7	3.04	36.3	1.3
5/1/2015	20.2	1.97	1.90	2.5	2.12	41.1	8.3

*Median dividend yield is only for dividend-paying stocks; all other data is for all stocks in the Stock Investor Pro database.
**10-year Treasury note; actual closing yield for each date.
Data from AAII’s Stock Investor Pro/Thomson Reuters and Yahoo Finance.

 

Come to Las Vegas for Great Investment Insight

As is often the case, our Investor Conference is selling out fast. The good news is that there is still time for you to sign up. The even better news is the list of speakers we have for this year’s conference.

Best-selling author Carl Richards will be one of our our keynotes. I’ve seen Carl twice and he is a great speaker. Not only does he give good insight into behavioral finance and portfolio management, he has the unique ability to convey complex concepts with sketches. (The New York Times, which publishes a regular column by Carl, calls him “the sketch guy.”) It’s entertaining to watch him draw while speaking in front of a large audience.

Also new to our conference is Jack Ablin. You might recognize the name from CNBC, Bloomberg or other financial media. Jack is the chief investment officer for BMO Private Bank. Jack interacts regularly with individual investors and understands their needs, desires and worries. Equally important, he can explain how individual investors can navigate their way through the ever-changing macro landscape.

Those of you who follow our Piotroski Screen will want to see Wesley Gray’s presentation. Wes, who explains his modifications to Joseph Piotroski’s strategy in this month’s AAII Journal, will discuss his quantitative approach to investing.

We’ll also have several popular speakers from past conferences returning this year, including CBS MarketWatch’s Market Hulbert, Morningstar’s Christine Benz, AFAM Capital’s John Buckingham (who discusses dividend investing in this month’s AAII Journal), former AAII Journal editor Maria Crawford-Scott and Computerized Investing editor Wayne Thorp.

I think you will find the conference to be both rewarding and informative. Visit AAII.com for more information and to register. I’m looking forward to seeing you there.

• Selecting a Valuation Method to Determine a Stock’s Worth – Not every valuation measure works with every stock; this article explains how to decide which measure to use for a given stock.
  
• Five Common Traits of Successful Value Screens – John Bajkowski discusses the five common valuation traits shared among the AAII value-oriented screens.
  
• Which Is Better: Current Valuation or Versus the Historical Range? – Do you assess a stock’s valuation based on its current (absolute) multiples or against what investors have historically been willing to pay?
  

Wayne Thorp and I will explain the philosophy behind the Model Shadow Stock Portfolio as well as how to successfully follow the portfolio in a special webcast on Tuesday afternoon. Space is limited, so if you are interested, register today.

Fewer than 20 members of the S&P 500 will report as earnings season shifts to retailers as well as smaller-capitalization companies. The only Dow Jones industrial average component on the calendar is Cisco Systems (CSCO), which will report on Wednesday.

The first economic reports of note will be released on Tuesday: the March Job Openings and Labor Turnover Survey (JOLTS). Wednesday will feature April retail sales, April import and export prices and March business inventories. The April Producer Price Index will be released on Thursday. Friday will feature April industrial production and capacity utilization, the University of Michigan’s preliminary consumer sentiment survey and the May Empire State Manufacturing Survey.

The Treasury Department will auction $24 billion of 10-year notes on Wednesday and $16 billion of 30-year bonds on Thursday.

San Francisco Federal Reserve Bank President John Williams will make a public appearance on Tuesday.

Optimism fell to a two-year low as neutral sentiment stayed above 45% for a fifth consecutive week in the latest AAII Sentiment Survey. Pessimism rose to a one-month high.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 3.8 percentage points to 27.1%. This is the lowest amount of optimism recorded by our survey since April 18, 2013 (26.8%). The drop puts optimism below its historical average of 39.0% for a ninth consecutive week, the longest such streak since an 11-week stretch between March 20 and May 29, 2014.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 1.1 percentage points to 46.1%. The increase keeps neutral sentiment above 45% for a fifth consecutive week, the longest such streak since a six-week stretch between May 13 and June 17, 1988. It also keeps neutral sentiment above its historical average of 31.0% for the 18th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, jumped 4.9 percentage points to 26.8%. Pessimism was last higher on April 2, 2015. Nonetheless, this is the 15th week this year with a bearish sentiment reading below its historical average of 30.0%.

Bullish sentiment is now at an unusually low level, while neutral sentiment continues to stay at an unusually high level. Historically, such readings—both unusually low bullish sentiment and unusually high neutral sentiment—have been correlated with better-than-average market performance over the following six- and 12-month periods. (See Analyzing the AAII Sentiment Survey Without Hindsight in the June 2014 AAII Journal for more information.) There is no guarantee history will repeat itself in the future, however.

Causing some AAII members to be cautious or pessimistic are prevailing valuations, recent price volatility, geopolitical events, the pace of economic growth, the impact of the stronger dollar on earnings growth and worries that a notable decline in stock prices could occur. Keeping other AAII members encouraged are the ongoing bull market, sustained economic expansion, earnings growth and still-accommodative monetary policy.

This week’s special question asked AAII members what their comfort level with current stock valuations is. (Most of the responses were given before Fed Chair Janet Yellen described stock valuations as “generally being quite high” yesterday.) About three out of every 10 respondents (31%) said valuations are high or that they are uncomfortable with how stocks are currently priced. An additional 16% of respondents described themselves as being cautious or are somewhat uncomfortable with current valuations or otherwise said that stocks are somewhat expensive. Close to 13% described stocks as currently either being fairly or fully valued. Just under 14% of respondents say they are comfortable with current valuations.

Here is a sampling of the responses:

• “I feel that stocks are somewhat overvalued, but I don’t see a minor bear market for at least six months.”
• “I think valuations are on the high end, but maybe not at their highs.”
• “There are many stocks whose price-earnings ratios fit in my comfort zone.”
• “Valuations are high, but there is nowhere else to get any kind of return.”
• “The recent economic measurements do not support current stock market prices.”
• “Stock prices are inflated because capital gains and dividends are the only game in town.”

Bullish: 27.1%, down 3.8 points
Neutral: 46.1%, down 1.1 points
Bearish: 26.8%, up 4.9 points


Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%

Cash allocations rose to their highest level of the year last month, according to the April AAII Asset Allocation Survey. Individual investors’ allocations to stock and stock funds ticked down slightly from March’s multi-year high. Bond and bond fund allocations also declined.

Stock and stock fund allocations fell to 67.9%, down 0.7 percentage points. In March, equity allocations had been at their highest level since June 2007. Even with April’s decline, stock and stock fund allocations remain above their historical average of 60%, which has now continued for 25 consecutive months.

Bond and bond fund allocations decreased 0.3% to 16.2%. Despite the decline, April is the 11th consecutive month with fixed-income allocations at or above their historical average of 16%.

Cash allocations rose 1%, to 15.9%. This was the largest allocation to cash since November 2014 (16.8%). April was the 42nd consecutive month with cash allocations below their historical average of 24%.

The five-month high in cash allocation occurred as neutral sentiment (as measured by the weekly AAII Sentiment Survey) has stayed at or above 45% for four consecutive weeks. This is the longest such streak since 1988. Despite the higher allocation to cash, equity allocations remain above average as the major indexes remain near their record highs and bond yields are at low levels.

Last month’s special question asked AAII members what asset classes they would invest in today if given an additional $50,000. We received a wide range of responses. Nearly 41% said stocks, which included responses that favored energy, health care and dividend-paying stocks. About 33% said stock funds, but many were weighted toward international stock, small-cap value and dividend-growth funds. Slightly more than 9% said they would allocate to bond funds and 6% said bonds. More than 11% of respondents said they would allocate to cash due to the belief that the market is overvalued or that they are waiting for a market correction.

Here is sampling of the responses:

• “Cash. I think stocks are overvalued and will correct and bonds will be hurt as interest rates increase.”
• “Dividend-paying stocks that are likely to be stable and worth holding for the future. Safer for markets ahead.”
• “International stock fund to reduce portfolio risk.”
• “Invest all the $50,000 in a U.S. equity index fund. I believe the general U.S. market will be up at the end of the year.”
• “$50,000 to bond funds to correct asset allocation drift.”

• Stocks and Stock Funds: 67.9%, down 0.7 percentage points
• Bond and Bond Funds: 16.2%, down 0.3 percentage points
• Cash: 15.9%, up 1.0 percentage points

• Stocks: 32.2%, down 0.6 percentage points
• Stock Funds: 35.7%, down 0.1 percentage point
• Bonds: 3.3%, down 0.6 percentage points
• Bond Funds: 12.8%, up 0.3 percentage points

Take the Asset Allocation Survey.

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