Bank of America strategist warns stocks are nearing 'Tech Bubble' levels
The stock market is getting expensive, and the analysts at Bank of America Merrill Lynch warn that many stocks are reaching valuations last seen during the tech bubble of the late 1990s.
The most popular way to measure value in the stock market is to take the price and divide it by earnings. This is the price/earnings (P/E) ratio. When the P/E ratio is above average, stocks are arguably expensive. When it’s below average, stocks are arguably cheap.
Most analysts have already observed that the average P/Es for the S&P 500 (^GSPC) are well above their five- and 10-year long-term averages, but they aren’t yet at levels seen during recent bubbles.
But the median P/Es tell a far more frightening story.
“The S&P 500 median P/E is currently at its highest levels since 2001 and suggests that the average stock trades a full multiple point higher than the oft-quoted aggregate P/E,” Bank of America Merrill Lynch’s Savita Subramanian observed. “This puts it in the 91st percentile of its own history and just 14% from its Tech Bubble peak.”
The disparity between the mean and median can be explained by the fact that there are many more stocks today with elevated valuations. But during the Tech Bubble, a relatively small group of stocks with eye-popping valuations skewed the mean higher.
Subramanian offered more color.
“Elevated stock valuations within the S&P 500 are driven chiefly by the mid caps—the most expensive size segment we follow—the median mid-cap stock trades in the 92nd percentile of its history,” she said. “The group keeping the S&P 500 aggregate forward P/E 30% below its Tech Bubble levels is the mega caps, which are trading well below their valuations at that time. The 20 largest stocks in 2001 were trading at a median P/E of 25x; today the 20 largest trade at 17x.”
All of this becomes much more troubling when you assume forecasts for forward earnings will come down. In fact, that’s exactly what Subramanian and many of her peers warn. Should those earnings estimates come down without a concurrent move in stock prices, valuations will only go higher.
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Sam Ro is managing editor at Yahoo Finance.
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