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Why The Stock Market Is Less Overvalued Than You Think

Shifting composition explains a lot of the market’’s premium valuation

(Not intended to be investment advice. Opinions are my own.)

A few weeks ago I published my thoughts on why we’re not in an epic stock market bubble yet:

There Is No Stock Market Bubble

Here’s some confirmation bias (my favorite type of bias) from GMO — in this paper, the author (GMO’s James Mendelson) deftly shows how a shift in weighting towards “always high multiple” stocks explains in large part the S&P 500’s supposedly bubbly valuation. Here’s my favorite chart from the paper:

Composition shift explains most of today’s higher valuations (Source: GMO)

What it shows is that when each stock in the S&P 500 is compared to its own respective historical median valuation, things don’t look too frothy. Rather, most of today’s higher than median S&P 500 valuation is explained by the increase in weighting of always high PE (Price Earnings)…