Every 6 months or so, I run some basic metrics to check the valuation of the S&P 500 in comparison to its historical average. I use this to as a guide to determine how much new investment capital to put to work in the US market.
The following pendulum graphs show the current S&P 500 earnings yield and dividend yield relative to the historical average. I've used a trailing 12-month earnings and dividend calculation from figures provided by Aswath Damodaran, Professor of Finance from NYU. The averages are calculated from 1961/62 onwards.
You can see that from a market earnings yield and dividend yield, the S&P 500 is expensive, but not in the excessive or sky high territory. We are still below 1 standard deviation above the historical mean. Growth investors will tend to look at the earnings yield metric while cash flow investors focus on dividend payments.
As of August 11, Thomson Reuters reported 71% of S&P 500 companies have beaten earnings expectations, 11% have matched expectations and 18% have reported quarterly earnings below the consensus estimate. So it would appear than a “disappointing earnings expectation initiated crash” is not in the immediate horizon. If we are due a crash, it's usually something totally unexpected (black swan) rather than the "usual suspects" the media get fixated on.
This stubbornly expensive market could be explained by the pendulum graphs you see on the bottom line. This shows the differential between S&P 500 earnings and dividend yields in comparison to the risk free rate. I have used the current interest rates on the 10-Year US treasury as a proxy for the risk free rate. In the past, the earnings yield as only exceeded the risk free rate by an average of 0.24%. However, in this exceptional low interest rate/low growth environment, we see the S&P 500 earnings yield exceed the interest rate on the 10 year treasury by whopping 3.29% compared to the paltry 0.24% it usually does. The dividend yield has lagged the risk free rate by a historical average of 3.4%, because most stock investors expect gains to come from increasing stock prices. They are happier to settle for much less dividend cash payments for much higher capital gains. Recent times have seen the market dividend yield actually exceed the risk free rate.
The extraordinary low interest rate environment of recent times provides a level of support and liquidity to the stock market. Investors have to put their money somewhere, and interest-bearing instruments have not been an attractive destination. Not everyone has the appetite to put their investment money in gold.
Attachment 8221
The reason I post these graphs is to provide a relative basis for where the market currently is in relation to its historical averages.
I think you can agree that they support the view recently expressed by legendary investor Howard Marks of Oaktree Capital:
"Asset prices are full today. I don't think we're in a bubble. But I view them as on 'the high side of fair' which means nothing is a bargain - nothing is available at laughably cheap prices."