Is the stock market too high?

Value is relative.  A lot of people discuss the market as up or down daily. The chuckleheads on business TV make their living putting the most interesting modifiers in front of X.

• The Dow is gushing up X this morning...
• The market tanked Y today...
• The yen went out for a pack of cigarettes and hasn't been seen since...
• T-bonds rallied, did a loop de loop and then went to the kitchen for some milk...

All of this is entertaining, but entertainment should be kept in its place, a seedy bar or family outing.   Price is relative to its value.

The S&P 500 is a proper equity index unlike the Dow and is currently priced very highly, especially if one considers its future earnings prospects relative to an inflationary environment.  Here is a chart from the Bespoke Investment Group.
The S&P is priced at  a PE of 19.09, thus yielding 5.2%.  This may be a bit higher than Cheech. 

• The current equity premium is about 1.67% over 10 year treasuries which is historically below the average equity risk premium of 2.5%-4.3%. Thanks Fama & French.
• Given the environment expectations for earnings growth next year may be a tad optimistic, of course treasuries could fall as well.

If one assumes that earnings will not contract in the future, then we are roughly 1-2.6% historically over priced in the stock market. 

If we assume that equities need to yield 1.8% more reflecting there historical risk premium, then the S&P 500 should be yielding 7% (have a PE of 14.2).  Here is the big headline, equities would have  25.6% more to drop for this to happen or treasury yields drop significantly.
 

For those in the entertainment industry reading this blog, that equates to 331 S&P points or approximately 3,000 points on the Dow taking it to Dow 8,800.  Now that could really make that puppy turn a few loops and sit quietly in the corner for awhile.