According to the unconventional valuation method of “output gap adjusted P / E ratio”, the S & P 500 index’s P / E ratio after output gap adjustment is far lower than the level shown by traditional indicators, and is at the lowest level since 1974-1982.
There is growing hope for therapies and vaccines that can help end the current public health crisis, but concerns that Wall Street’s stock market has become overvalued and far ahead of its time continue to haunt many investors.
However, Jim Paulsen, chief investment strategist at the leuthold group, an investment research firm, said in a research report released on Monday that, given the nature of the new coronavirus outbreak that triggered the market crash in March, it may be reasonable to adopt an unconventional approach to the evaluation of stock prices.
“Almost all of the traditional valuation measures show that the stock market is trading at near all-time highs.” Paulson wrote in his report. “If the traditional valuation model is accurate, then the upside potential of the stock market seems to be very small, and there will eventually be considerable downside risk.”
In fact, according to the data of The Leuthold Group, according to the traditional market valuation method, the S & P 500 index now has a 26 P / E ratio, the highest level since the Internet bubble period.
Nevertheless, Paulson has proposed a way of looking at valuations, which may serve as a guide to keeping people open about the possibility of greater upside space for the stock market in the current environment.
“Our goal is not to create a new ‘best’ valuation technique that outperforms all other techniques; instead, we use the output gap adjusted P / E ratio.” He wrote.
The so-called “output gap adjusted P / E ratio” (OGA P / E) is to calculate the percentage difference between the current U.S. real GDP level and its estimated potential level if the economy is in full employment, and adjust the past performance P / E ratio according to the degree that the output gap lags behind the average level since 1950.
“Specifically, if the output gap is average, the P / E ratio will not be adjusted.” The analyst explained. “However, if the output gap is one standard deviation below the average level, the traditional P / E ratio will decrease by one standard deviation; if the output gap is more than one standard deviation of the average level, the traditional P / E ratio will increase by one standard deviation.”
According to this measure, the price earnings ratio of the S & P 500 index adjusted by the output gap is far lower than the level shown by the traditional indicators, and is at the lowest level since 1974-1982.
Paulson admits that this approach is unscientific, but he thinks it’s the starting point for talking about the richness of stocks. “While the S & P 500’s current P / E ratio is far from a record low, the” output gap adjusted P / E ratio “may be correct, suggesting that the index may be cheaper than most people think,” he wrote
“In each of the previous cases, the bull market followed, and lasted for several years, despite the high valuation of the stock market. Will this happen again today? ” Paulson asked.