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Valuing the S&P 500

Brian Sturgess - June 2013

Speed Read
  • Three models used to measure the relative valuation of US equities all suggest the S&P 500 is moderately overvalued.
  • An alternative method, adjusting the S&P 500 to account for inflation also suggests that the real value of the market is moderately overvalued.
  • The deflated S&P 500’s average value has been close to the trend rate of growth in real GDP growth with periods of underperformance from 1974 to 1994 and outperformance from 1995 to date.

The relative value of the S&P 500
Three approaches are used to assess the value of the equity market as a whole relative to other assets. These models can be categorised as follows: Shiller’s Cyclically Adjusted Price-Earnings model (CAPE), Tobin’s Q (QR) and the Equitisation Ratio (ER). All of them measure the percentage under or overvaluation of the S&P 500 market index in relation to the ratio of the current value to the long-run average of the relevant variables. None of these methods seek to advise investors on precise market timing, but only on the relative long-term value of equities. Two of the methods – QR and ER are assessed on a quarterly basis given the frequency of required data releases while CAPE can be calculated every month. All three methods are suggesting that the US equity market has entered an overvaluation phase since 2009. The longer term picture of the percentage valuation of the S&P in relation to long-run averages of CAPE, QR and ER are shown from 1952 to the end of 2012 in Chart 1 and from the start of 1998 to the end of 2012 in Chart 2. Details of these mo...

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