Included in this week’s update (the usual weekly charts):

  • S&P 500 Index Median PE Overvalued and Undervalued Price Targets (as of February 28, 2014)
  • Sentiment Charts – Crowd Sentiment is Extremely Optimistic: Hedge
  • Cyclical Equity Market Trend Charts – Both Trend Charts Remain Bullish
  • Provided are several links to learn more about the use of options to hedge

S&P 500 Index Median PE Overvalued and Undervalued Price Targets

In the next chart, we look at the median price to earnings ratio (PE) to get a sense of current valuation. Are U.S. equities, in general, inexpensively priced or expensively priced?  If we buy an inexpensively priced asset, there is greater future return potential.  Stating the obvious, if we pay too much, our return potential is more limited. Not a problem is you have a 20-30 year time horizon and the ability to stay the course when turbulence hits (2002, 2008, etc.). It is a problem when a major correction occurs just prior to your retirement.

There are many ways to measure valuation.  I favor median PE for it is a mathematical process based on ACTUAL earnings.  History has shown that Wall Street analysts tend to over-estimate future earnings.  The challenge for those who favor forward earnings estimates to calculate PE is that there is a long pattern of those estimates subsequently being revised lower.  Thus, this is too much of a moving mark for me.

Median PE gives us a very good picture of current market valuation and helps frame short-term to intermediate-term upside and downside price targets vs. historical levels. This understanding can prove valuable in the management of your money.  For example, one might wish to hedge downside risk when prices become richly priced.  The reverse is true when valuations are attractive. 

Here is how to read the chart.  The current Median PE is 20.5 (data through 2-28-14). The 50 year median PE is 16.7.  If you take the most recent reported earnings (median calculation) and times it by the 50 year average PE of 16.7, you get a suggested fair value of 1517.53.  A 1 standard deviation move above 16.7 suggests the market is overbought at 1987.32.  This is approximately 18.4% below the current levels. Here is the chart.

Read the rest of the report…


Steve Blumenthal

Founder & CEO CMG

Stephen Blumenthal founded CMG in 1992. He is CEO, Chief Investment Officer and portfolio manager at Capital Management Group, Inc. where he manages equity and tactical investment portfolios. He is a frequent speaker and writer on investment strategies and has been featured in various media sources including the Wall Street Journal, Barron’s, Investor’s Business Daily, Pensions & Investments Magazine, Investment News, RIA Biz and Smart Money. He has been a guest on CNBC, Wall Street Journal Live, and Bloomberg. Mr. Blumenthal is a frequent speaker at industry conferences (NAPFA, IMCA, Index Universe, Opal Financial Group Indexing & ETF Summit and NAAIM) and is author of CMG’s popular investment research commentary. With 30 years of investment management and industry experience, prior to founding CMG, Mr. Blumenthal worked for Merrill Lynch Institutional, Merrill Lynch Retail and Prudential Securities.

Mr. Blumenthal graduated with a Bachelor of Science degree in Accounting from Pennsylvania State University. He is married, has three children and is active in his community coaching youth soccer.