Is the American Stock Market Overvalued?

Market capitalization versus the long-run equilibrium

The plot compares logged total market capitalization to long-run equilibrium levels (estimated from cyclically adjusted corporate earnings). Click and drag to examine a particular area, and double-click to return to the original position. (On touch screens, the zoom-functionality is disabled.)

The American stock market currently appears to be overvalued by 65%. In other words, it would take a 39% drop to bring the market back to its long-run equilibrium level. At the last all-time high, on November 8, 2021, the market was 76.6% overvalued. In comparison, at the peak of the Dot-com bubble, on March 24, 2000, the market was 88.7% overvalued. When the market bottomed out 2.5 years later, it had dropped 50.2% from its previous all-time high and was undervalued by 20%.

These estimates are based on a model that is inspired by Shiller’s cyclically adjusted price-to-earnings ratio (CAPE). We find the CAPE measure preferable to the market cap-to-GNP ratio, as it accounts for long-term changes in the ratio of corporate profits to GNP. The model estimates the long-run equilibrium between stock market capitalization and cyclically adjusted corporate earnings.

The fact that the market currently appears overvalued does not necessarily mean it will correct back any time soon. The forces pulling the market toward the long-run equilibrium are relatively weak and allow the market to stay over- or undervalued for extended periods of time: From 1954 to 1970, the market stayed continuously overvalued for over 15 years, and from 1973 until 1987, it stayed undervalued for about 14 years.

Deviations from the long-run equilibrium

The plot shows how logged total market capitalization has deviated from the long-run equilibrium level over time. Click and drag to examine a particular area, and double-click to return to the original position. (On touch screens, the zoom-functionality is disabled.)

Nominal trends since 1990

The plot compares nominal total market capitalization to long-run equilibrium levels (estimated from cyclically adjusted corporate earnings). Click and drag to examine a particular area, and double-click to return to the original position. (On touch screens, the zoom-functionality is disabled.)