Over the last few months, the C Fund (which tracks the S&P 500) has gradually recovered most of its losses from its 10% correction at the beginning of the year:
This is good news for many investors, as nobody wants to see their TSP value go down for long. However, it is yet again putting the C Fund in potentially overvalued territory, based on several valuation metrics.
For example, the cyclically-adjusted price-to-earnings (CAPE) ratio of the S&P 500 has once again touched 33x, which puts it at the second highest level in history:
In addition, the total price of all U.S. stocks (market capitalization) is back up to 145% of GDP, making it roughly tied as the highest ever:
In addition, the price-to-sales and price-to-book ratios of the C Fund both are at peaks not seen since the Dotcom bubble:
Even just over the past several years since 2014, the price-to-sales ratio and price-to-book ratio of the C Fund have both increased by about 30%.
In other words, if earnings and revenue of all companies were to stay the same but valuations today were to revert to what they were in 2014 just 4-5 years ago, the C Fund would lose 30% of its value. It would probably take a recession to trigger a de-valuation like that, but it’s something TSP investors should be aware of.
No valuation metric is perfect, which is why it’s useful to consult several metrics. For example, a portion of the increase in price-to-book and price-to-sales ratios is due to the increased allocation towards technology stocks in the S&P 500 over the past decade. Tech stocks often have higher profit margins and fewer physical assets, meaning they can generate quite a lot of earnings relative to sales and book value.
In addition, as long as interest rates remain so low (the 10-year treasury currently yields just under 3%, or less than 1% after adjusting for inflation), it’s rational for stocks to have relatively high valuations. This level of valuation is not truly at any sort of “bubble” territory, but rather is just quite high, and it’s worthy for investors to be aware and cautious about it.
When valuations are this high, investors can protect themselves by remaining diversified, keeping a long-term view, and having realistic (i.e. lower) estimates for forward rates of return in regards to retirement planning.