The last time US stocks were this pricey relative to the debt market, the S&P 500 crashed 50%

Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2023 in New York City.

Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2023 in New York City.Michael M. Santiago/Getty Images

  • US stocks are near their most expensive levels in over two decades, relative to the debt market.

  • The last time stocks were this pricey versus debt was during the dot-com boom – that was followed by a 50% crash in the S&P 500.

  • “Equity risk premium is near its worst ever level going back to 1927,” and previous such instances have triggered major market corrections, research firm MacroEdge said.

US stocks surprised much of Wall Street this year with a strong run that defied decades-high interest rates and recession calls. The rally was fueled by slower inflation and hype over artificial intelligence.

But more recently, the Federal Reserve’s unwavering higher-for-longer rate stance and a deepening bond-market rout have had a sobering effect on equities sentiment, with the S&P 500 index paring its year-to-date gains.

Indeed, according to Insider’s own research, stock valuations are looking increasingly stretched, raising the risk of a correction.

One such indicator in particular is flashing red – the relative valuation of stocks versus the debt market.

Stocks performance versus debt, over time

Stocks performance versus debt, over timeKoyfin

In August this year, the S&P 500 climbed to levels last seen during the peak of dot-com boom, relative to an index that tracks the US corporate bond market, according to data from global analytics platform Koyfin. The gauge is still holding near those highs, despite the recent pullback in equities.

The metric last surged this high in the spring of 2000 — and that was followed by a multi-year meltdown in stocks that saw the S&P 500 crash 50% between March 2000 and October 2002.

S&P 500 declines during 2000-2002

S&P 500 declines during 2000-2002Koyfin

Another indicator that shows the richness of stocks relative to debt is the so-called equity risk premium — or the extra return on shares over government debt, which is considered a safer form of investment. The metric has plunged this year lows unseen in decades, indicating elevated stock valuations.

“Equity risk premium is near its worst ever level going back to 1927. In the 6 instances this has occurred, the markets saw a major correction & recession/depression – 1929, 1969, 99/00, 07, 18/19, present,” research firm MacroEdge said in a recent post on X.

A similar sentiment has been echoed in recent months by several other experts, including Pictet Asset Management chief strategist Luca Paolini.

“The so-called equity risk premium (earnings yield minus bond yield) recently fell to a new cycle low and remains well below historical averages. In other words, the stock market has become more expensive relative to the bond market despite the recent pullback,” financial news analysis outlet recently cited Roth MKM analyst Michael Darda as saying.

Stocks are far too expensive and a recession will probably hit the US economy within the next three quarters or so, billionaire investor Jeffrey Gundlach said last month.

“I think the market is pretty overvalued,” the CEO of DoubleLine Capital said on a company webcast. “It’s hard to love equities when the risk premium is the lowest in 17 years, by a lot.”

Read the original article on Business Insider

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