The S&P 500 PEG Ratio Is Low: Why It's A Bearish Sign

The price-to-earnings-to-growth (PEG) ratio is a fundamental valuation metric that assesses a stock’s price relative to its earnings and expected earnings growth rate. In theory, the lower the PEG, the more value a stock holds.

The S&P 500 currently has a forward PEG of just 1.11, 21% below its historical average. But Bank of America analyst Savita Subramanian said Monday that most fundamental valuation metrics suggest the stock market is overvalued, and the low PEG ratio may actually be just one more sign of irrational market exuberance.

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The Numbers: Subramanian said the S&P 500 is statistically expensive based on 15 of 20 fundamental metrics he tracks, including a Shiller PE that’s 122.9% above historical norms and an S&P 500 Market Cap/GDP ratio that’s 170.3% above historical averages.

In fact, Subramanian said the only reason the S&P 500’s PEG is so low is because analysts have such high expectations for future earnings growth.

“The attractive P/E to [long-term growth] ratio, or ‘PEG ratio,’ of the S&P 500 is due to lofty growth expectations, not low valuations,” he said.

High Expectations: Analysts are currently projecting long-term S&P 500 earnings growth of 19%, even higher than peak dot-com bubble growth expectations. Like many economic and market sentiment measures, Subramanian said long-term growth expectations have historically been a better contrary indicator than positive indicator. In fact, of the 87 companies that had long-term earnings growth expectations back in 2000, only 15 actually delivered at least 20% LTG over the next five years, Subramanian said.

LTG projections have historically had a negative 40% correlation to 12-month forward S&P 500 returns. If that correlation were to hold over the next 12 months, it would suggest about 20% downside for the SPDR S&P 500 ETF Trust (NYSE: SPY) by November 2022.

Benzinga’s Take: Predicting market moves is far more complicated than analyzing one or even a handful of metrics, such as LTG projections or PEG. However, if 75% of Bank of America’s valuation metrics currently suggest stock valuations are historically high, investors should be prepared for the possibility of a steep correction if the Federal Reserve begins raising interest rates in 2022.