Bank of America Corp (BAC), Citigroup Inc (C): Is the Stock Market Getting Frothy?

Page 1 of 2

Bank of America Corp (NYSE:BAC)Given that the Dow Jones Industrial Average (Dow Jones Indices:.DJI) recently crossed the 15,000-point threshold for the first time in history, it should come as no surprise that there’s an ongoing debate about whether stocks are headed for another bubble.

The title of a recent CBS MoneyWatch article sums up the sentiment perfectly: “Stock Market Bubble: Red flag warning.” According to the author, there’s reason to believe that stocks are becoming “frothy” because margin debt — that is, the debt that investors use to purchase stocks in the brokerage accounts — is headed for another peak akin to the dot-com and housing bubbles. Here’s a chart to demonstrate the point:

But there’s another side to this story. Enter Josh Brown, author of The Reformed Broker — a blog I encourage readers to check out. In a post published at the end of last week comparing the stock market in 1999 to today, Josh makes a convincing argument that all of this concern is much ado about nothing.

Here’s a very rudimentary but essential thing to be aware of — in 1999 the S&P 500 finished at 1469, earned 53 bucks per share, and paid out $16 in dividends. These are nominal figures, not adjusted for inflation.

The 2013 S&P 500 is earning double that amount — over $100 per share. The index will also be paying out double the dividend this year, more than $30 per share, and returning even more cash with record-setting share repurchases.

This sounds pretty good; what’s the catch?

What kind of premium, pray tell, are we paying for double the earnings and twice the dividend yield versus 1999′s market? I’m so glad you asked — turns out we’re not paying any premium at all. We’re paying a discount. 50% off. The current S&P 500 trades for a P/E of 14 versus 33 for 1999. So double the fundamentals for half the price.

Sound frothy to you?

Josh then goes on to discuss the Case-Shiller cyclically adjusted P/E ratio, or CAPE. For those of you who aren’t familiar with this metric, it’s a 10-year rolling average of the S&P 500′s P/E ratio. Its advantages are twofold. In the first case, it’s the most widely available historical valuation metric you can find for the broader market — do a search for the S&P 500′s historical P/E ratio, and it’s basically the only game in town. And in the second case, as its name suggests, by controlling for cyclical variations in valuation multiples, it makes for a nice, smooth line to include in charts.

But, as Josh points out, there’s a problem with relying on this metric to make contemporaneous investment decisions. That is, by including the last 10 years of valuations, the CAPE overstates the S&P 500′s current multiple by nearly 38%. You can see this in the following chart, which compares the index’s actual P/E ratio to the CAPE.

S&P 500 P/E Ratio Chart

S&P 500 P/E Ratio data by YCharts

Suffice it to say, the current gap is a function of the financial crisis, shortly after which corporate earnings were eviscerated and thus valuation multiples shot through the roof. This trend was particularly robust in the financial space, where large banks such as Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) were forced to record massive losses because of overexposure to subprime mortgages.

Page 1 of 2
blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

7 Most Expensive Cities in the World

5 Least Expensive Cities in the World

Celebrities Who Believe In Scientology

10 High Margin Food Products to Build a Business Around

The 10 Most Expensive Clothing Stores in the United States to Get Decked Out At

The 5 Biggest Kickstarter Scams That Swindled Backers’ Donations

The 10 Most Expensive Boarding Schools In the World

50 Crazy Facts About Japan You Won’t Believe

Top 10 Least Expensive Hybrid Cars to Save the Planet With

The 10 Biggest ‘Gate’ Controversies in History

The 10 States with the Highest Nursing Shortages Leaving Their Hospitals Depleted

The 10 Best Value Investment Blogs that Every Investor Must Read

The 6 Cheapest Boarding Schools in Europe 2015

The 5 Most Expensive Cars To Insure in the World

The 10 Most Common Genetically Modified Foods

10 Self-Made Billionaires Who Came From Nothing

The 10 Most Expensive Cities to Live in North America

The 13 Most Expensive Headphones in the World to Represent

The Top 20 Wealthiest Soccer Teams in 2014

4 BuzzWorthy Cannabis Stocks And Some Smoking Derivative Plays

The 10 Healthiest Fast Food Chains in America to Dine At

The 5 Most Expensive Cat Food Brands You Can Spoil Your Kitty With

The 6 Best eCommerce Platforms for Small Businesses

The 10 Worst Mistakes an Entrepreneur Can Make

The 5 Most OP Characters in League of Legends to Carry Games and Crush Foes With

The 5 Best Foods to Eat Before Running that Will Help You Pound the Pavement

10 Glaring Plot Holes in The Walking Dead that a Zombie-Filled Bus Could Drive Through

The 5 Biggest Celebrity Stoners Who Love Their Reefer

The 10 Most Overrated Movies Of All Time by Out-of-Touch Critics

Top 6 Least Expensive Cruise Destinations For 2015 that Will Take You to Paradise

10 States with Lowest Substance Abuse Rates in America

The 14 Most Watched TV Finales Ever

The 10 Best Selling Role Playing Games of All Time for PC

10 Most Influential Papers In Economics

Top 8 Biggest Charities in the US

10 Worst Celebrity Career Moves Ever

Top 10 Best Paid Tennis Stars in the World

Top 6 Cities For The Ultra Rich to Live in Comfort

10 Cities with High Demand for Nurses

6 of the Worst Greeting Card Messages Ever Crafted

How to Make Money in ArcheAge and Build Your Empire

10 Foods To Eat To Lower Cholesterol Levels

The 10 Most Hated Television Characters of All Time

The 30 Worst Halloween Costume Ideas Ever Brought to Horrible Life

10 Vocational Skills in Demand Today with Jobs Waiting to be Filled

10 Best Places to Visit in Central and South America

The 10 Greatest Empires in History Which Nearly Conquered the World

The 6 Cheapest Boarding Schools In America 2015

5 Clear Reasons LoL is Better than DotA, Continues to Rule MOBAs

The Only 9 Teams with a Chance to Win the Super Bowl

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!