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“We have been warning investors for some time that U.S. equities – and particularly growth stocks – are overpriced,” Joe Davis, the firm’s chief global economist, wrote in a commentary.
“In fact, the stock market’s cyclically adjusted price-earnings ratio is about 32 percent above our estimate of its fair value.”
The CAPE multiple, developed by Nobel Prize-winning economist Robert Shiller, takes into account ten years of average earnings rather than just a single year, as is the case with standard PE multiples. The idea behind it is to mitigate the impact of a year of differing earnings.
The CAPE multiple was 36.23 on August 27, a level that has not been reached since August 19.th Century only during the dot-com bubble of the late 1990s and the post-pandemic recovery in 2021.
Vanguard’s perspective in context
However, the danger is not all-encompassing, Davis said. “While growth stocks and the broader equity market appear overvalued, small-cap stocks, value stocks and non-U.S. stocks appear fairly valued,” he wrote.
Related: Top value fund manager says Google parent Alphabet is a deep value stock
The market mania surrounding artificial intelligence was a major factor in boosting stock prices last year. This enthusiasm is exaggerated, said Davis:
“It is unlikely at best that the rapid economic and earnings growth (attributable to AI) would correct the current overvaluation of the U.S. stock market.”
To free the market from its overvalued status, earnings would have to increase significantly, he said.
If one assumes a time horizon of three years for the return to fair value, profits would have to increase by 40% annually to reduce the market excesses.
“That’s twice the annualized rate of electricity generation in the 1920s – not to mention economic output and corporate profit and loss statements,” Davis said.
Goldman Sachs issues short-term equity outlook
On the other hand, Goldman Sachs is optimistic about stocks, at least in the short term.
Corporate share buybacks and trading transactions based on computer algorithms are fueling this development, says Scott Rubner, managing director of global markets and tactics specialist at Goldman.
“We estimate there is $17 billion of emotionless demand between robots and companies every day this week,” he wrote in a commentary on Monday quoted by Bloomberg. “There is a very positive three-week equity trading window through Sept. 16.”
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Meanwhile, “the sellers are running out of ammunition,” said Rubner. He probably means that the stock bears, who suffered so many losses last year through short selling, are no longer willing to sell any more shares short.
“Everyone is going back into the pool,” he wrote. Algorithmic traders have exceeded their downside risk on stocks.
Goldman has suggested that the US Federal Reserve’s signal to cut interest rates next month could temporarily support stock prices.
“The pain trades in stocks are higher and the bar for being bearish from the beach to the Labor Day barbecue is high,” Rubner wrote last week, continuing his metaphor of summer fun.
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