The Stock Market's Current Valuation Is Just Right For A 'Rational Exuberance' Scenario

Ed Yardeni

$('.icon-tooltip').tooltip();NOTE: This post was first published on June 10, 2013.

Let’s return to the question of how much investors should pay for growth. Since 1995, Thomson Reuters I/B/E/S has been compiling analysts’ consensus short-term earnings growth (STEG) expectations over the next 12 months (52 weeks since 2005) for the S&P 500. Data are also available for long-term growth (LTEG) expectations over the next five years. The latter series peaked at a record 18.7% during August 2000, just when the Tech bubble burst. It then declined to a low of 9.4% during May 2009. At the end of May, it was 10.9%.

We can compute a PEG ratio for the S&P 500 using the forward P/E and dividing it by LTEG. This ratio recently bottomed at 0.93 during the week of November 24, 2011. It is now back up to 1.30. Is that too high? Not really: It is back to the average of this series since 1995. Given that analysts’ long-term growth expectations are clearly optimistically biased, think of this average as the “normalized” fair value of the PEG.

In other words, the P/E is just about where it should be in our Rational Exuberance scenario, to which we assign a 60% subjective probability. P/Es exceeding say 15 would be more consistent with our Irrational Exuberance scenario (30%).

Ed Yardeni

Today's Morning Briefing: Pegging PEG. (1) The expansion is slow and old, and could last another four years. (2) How much should investors pay for slow but prolonged growth? (3) Pessimistic professor turns optimistic on next four years. (4) Running on fumes or on pent-up demand? (5) PEG is at normalized fair value. (6) The trend growth rate for earnings is 7%. (7) Forward earnings still rising to record highs. (8) Focus on overweight-rated S&P 500 Industrials. (More for subscribers.)

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