The purpose of this disclosure is to explain how we make money without charging you for our content.
Our mission is to help people at any stage of life make smart financial decisions through research, reporting, reviews, recommendations, and tools.
Earning your trust is essential to our success, and we believe transparency is critical to creating that trust. To that end, you should know that many or all of the companies featured here are partners who advertise with us.
Our content is free because our partners pay us a referral fee if you click on links or call any of the phone numbers on our site. If you choose to interact with the content on our site, we will likely receive compensation. If you don't, we will not be compensated. Ultimately the choice is yours.
Opinions are our own and our editors and staff writers are instructed to maintain editorial integrity, but compensation along with in-depth research will determine where, how, and in what order they appear on the page.
To find out more about our editorial process and how we make money, click here.
Stock prices are still well-below their late-February highs. But are stocks actually a good buy? Right now experts strongly disagree. That means for investors, there’s a lot riding on which measure you chose to peg the market’s fair value.
As COVID-19 continues to spread, stock-market indexes have been whipsawing all over the place, and future earnings are murky at best. It’s as if we’re all pilots flying into a deep fog. It’s more important than ever to trust your flight instruments, even as many seem to be giving strange or contradictory readings.
“If I were to tell you a year ago that unemployment would go to 20%, interest rates would go to zero, gold would be up by a third, volatility in stocks would triple, oil would be down 70%, and yet stocks would be up in the last 12 months, would you have believed me?” asks Meb Faber, founder and chief executive of Cambria Investment Management in Manhattan Beach, Calif.
It’s a head-scratching moment, for retail investors and professionals alike, because no one really knows what lies ahead. We could develop a vaccine, and the economy could snap back to normalcy; or the virus could continue to circle the globe, and economies could persist in a kind of medically-induced coma.
If visibility is poor, all we can really do is rely on the best valuation data available. But those readouts can change over time – and very smart people can have very different interpretations of what those numbers are telling us.
To help chart your way forward through this storm, let’s break down the numbers:
Why some think stocks are cheap
Market indexes seem to have hit a recent bottom on March 23, when they were down about 30% from previous highs. Since then they have rebounded – but the S&P 500 is still down around 15% from late February.
To some observers, that indicates a buy. Chicago-based research firm Morningstar actually compiles a fair-value index for all U.S. stocks; when that index stands at 1, it indicates equities are fairly valued.
Right now it is at 0.91, suggesting that stocks are 9% undervalued. In late March, that index had fallen to 0.7, indicating a 30% bargain.
“We think stocks are still slightly undervalued overall right now,” says Preston Caldwell, senior equity analyst at Morningstar. “In our view, the market continues to slightly overrate the long-run economic impact from Covid-19, particularly as it pertains to a few sectors which are the most undervalued — especially energy stocks, banks, and airlines.”
To wit, Morningstar only forecasts a coronavirus-related GDP hit of about 1%, much less than during the financial crisis of 2008. “Economic confidence should recover quickly once the virus subsides,” Caldwell says.
Why some think stocks are expensive
The challenge with a forecast like that, is that we have no date certain about when that subsiding will take place.
In the meantime, all we can do is look at standard metrics for valuing stocks, such as price-to-earnings ratios (P/Es). As of May 1, the S&P 500’s trailing 12-month P/E was 24.2, according to WSJ.com (https://www.wsj.com/market-data/stocks/peyields). For sake of comparison, that figure was 21.8 a year ago.
Over a longer-term horizon, that average is roughly 15. Seen through that lens, the current market is hardly a bargain.
“Our conclusion is that U.S. stocks are broadly expensive right now,” says Cambria’s Faber. “It’s not crazy, like the bubble in the late ‘90s – but the market is pricey, and we’re in a downtrend, which is not a warm and fuzzy place to be.”
Faber’s preferred valuation metric is the so-called Shiller P/E – which is based on the past 10 years’ earnings, designed to give a broader and more accurate picture beyond short-term business cycles. That figure stands at 27, or more than 50% higher than its historical mean of 17 (https://www.multpl.com/shiller-pe).
Then there are forward P/Es, based on estimations of earnings to come. Those ratios are harder to pin down, since they are based on educated guesswork which may or may not come to pass. If earnings projections are slashed, forward P/Es can change in a hurry and stock prices can drop, as we saw in the financial crisis of 2008.
By the beginning of May, the forward P/E for the S&P 500 stood at 20, after plummeting during the market’s apparent bottom in late March, according to analysis by Yardeni Research (https://www.yardeni.com/pub/stockmktperatio.pdf).
What to do
Of course, both assertions about valuation can be true at the same time. Market averages are one thing, but every sector and every company is valued differently. Big technology stocks have been relatively unscathed, for instance, while small-cap value stocks have been getting hammered.
The same thing is true of regions: Faber points out that while the U.S. appears somewhat expensive, the rest of the world is fairly valued, and emerging markets in particular look cheap. So investors might be wise not to double down on U.S. equities, but to shift towards a more global portfolio with 50% of holdings abroad.
The point is not to panic about where valuations stand on any given day – going all-in or all-out, for example. “Don’t feel you have to move in absolute terms, but just tilt and calibrate,” says Faber. “That’s the most sensible thing for most investors.”