The Stock Market is Historically Overvalued and Here's Why It Doesn't Matter
According to its price-to-earnings ratio (30x), the S&P 500 is valued more than 80% higher than its long-term average (16x). But the historical averages are irrelevant.
The current compilation of the 505 companies in the S&P 500 is representative of the US economy in over 11 sectors. We forget that it wasn’t always this way. Over time, the index composition has transformed and skewed away from low-value and towards high-value businesses. Let’s review the timeline of the S&P 500:
During the first 50 years (1926-1976), the S&P 500 was comprised only of industrials, railroads, and utilities. These businesses/sectors often have tremendous infrastructure and inventory costs, low margins, and (appropriately) low valuations (P/E ratios). Then, financials got involved in the late 1970s, also with (usually) low valuations. A few computer companies like Apple and Microsoft snuck in during the 1980s, but we didn’t get full tech sector representation until the early 2000s.
How can you compare today’s S&P 500 index (dominated by high-margin, global tech, communication and healthcare brands) to an index which was almost exclusively industrial stocks for the five decades spanning jazz to disco?
The benchmark has changed, and so should our way of measuring the markets.