Valuation Update: We estimate that the S&P 500 is currently priced to deliver total returns over the next decade in the range of 6.5-9.0%, centered at an expected total return of about 7.8% annually. Stocks are modestly overvalued here, except on metrics that assume a permanent recovery to 2007's record profit margins (which were about 50% above the historical norm).
On normalized profit margins, sustainable S&P 500 earnings are slightly above $60 on the index. That's certainly higher than the 7 bucks of net earnings that companies in the index have reported over the past 52 weeks, but unfortunately, even at current prices, the S&P 500 is near 16 times normalized earnings.
You can get that basic figure a lot of ways. Currently, book value on the S&P 500 is slightly above $500. Outside of the past 15 years, when the economy was building up to a debt crisis, the typical return on equity for the S&P 500 has historically ranged between about 10-12%. While a higher debt load raises return on equity in good times, it also leads more quickly to bankruptcy in bad times, as we've observed, and will continue to observe. The deleveraging pressure on the
Presently, the price-to-book ratio on the S&P 500 is about 1.9. If you think about the 1974 and 1982 lows, we observed price/book ratios at about 0.8, while price-to-normalized earnings multiples were at about 7. So the S&P 500 would have to drop by about 60% to match the best valuations that we've seen during the past 40 years. Investors shouldn't kid themselves that stocks are cheap – in the sense of being priced to deliver outstanding long-term returns – just because we've observed a wicked decline. We're not even close.