U.S. stocks are darn expensive. There's no disputing that.
We're in the middle of a market Melt Up. And the incredible gains we've seen – along with an economic slump that slowed earnings – have pushed valuations to incredible heights.
Specifically, the S&P 500 Index is trading at its highest valuation since the dot-com peak in 2000.
The S&P 500 trades at a price-to-earnings (P/E) ratio of more than 30. It rose above that level for the first time in two decades earlier this month.
Now, while high valuations are a warning sign... they are not a signal that a crash is imminent.
In fact, high valuations are a good thing in a market like the one we have today. And they could rise even higher as the Melt Up continues.
Let me explain...
The P/E ratio is one of the easiest ways to value a market. It's a gauge of how much you are paying for the amount of earnings you receive in return. The higher the P/E ratio, the higher the "price tag" for stocks.
Today, valuations are near record highs based on this common measure.
This is exactly what you'd expect during a Melt Up like we're experiencing today. Investors buy into the incredible rally, no matter the price. This drives valuations through the roof.
We can see this play out in the chart below. The P/E ratio for the S&P 500 soared in the final innings of the late-1990s Melt Up. Take a look...
From October 1998 to April 1999, valuations jumped more than 35%. And the P/E ratio hit 30 for the first time in April 1999.
But panic-selling then would have been a terrible mistake. Those high valuations didn't cause a crash.
Instead, the S&P 500 rallied another 19% to its peak in late March 2000.
The market's P/E ratio was at or near 30 for an entire year leading up to the 2000 peak. And that goes to show, high valuations can last for a while... and get even higher in the meantime.
Today, the broad market has only been at 30 for a few weeks. So yes, U.S. stocks are expensive. But they can remain expensive for longer than you think. And the market could rally much higher before an eventual peak sets in – with huge gains for individual stocks.
It's important to keep an eye on valuations. But they're not a reason to flee to safety just yet.
Instead, with the trend in our favor, the smart move continues to be staying long stocks.
Good investing,
Chris Igou
Further Reading
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