How to Know if Stocks are Too Expensive?

Dr. Ed Yardeni says they aren’t, using the real earnings yield as a measure. He also explains why he likes this measure of value over others and what it’s saying today.

As I observe in my book, there are lots of valuation models. None are infallible. None are right all the time. I like the REY model because it does reflect the impact of inflation on valuation. As John observes, “Inflation is absolutely crucial for long-term investors. It’s the most important macro factor. Oddly, the market is stuck on the P/E ratio.” I agree and devote Chapter 4 of my book to “Predicting Inflation.”

The average value of the REY since 1952 has been 3.3%. Presumably, the market is fairly valued around this level, undervalued above it, and overvalued below it. The REY was 2.6% during the first quarter of this year. Since the late 1960s, it worked relatively well as a bear market leading indicator when it fell closer to zero. It also turned out to be a relatively good bull market indicator when it rose back above zero and exceeded its historical average.