S&P soared nearly 30% in 2013 as P/E ratios expanded The most recent pullback on Wall Street has piqued the interest of bargain hunters on Wall Street. With so many stocks bruised by last week’s choppy markets, these investors’ hope is that shares have fallen enough to offer an attractive value. But the truth is stocks remain pricey. The S&P 500 SPX, +1.96% dropped 9.8% from peak to trough on an intraday basis, before bouncing back in earnest on Friday. The selloff dampened price-to-earnings ratios. Twelve-month forward P/Es are at 14, while trailing P/Es came down from 16.9 in September to 15.9 today. At these levels, stocks are priced fairly, if you consider historical averages as a measure of fair price. Historical averages of the past 20 years include two periods in which stock markets experienced huge bubbles, lifting price-to-earnings ratios markedly. So, while earnings on the S&P 500 have grown to record levels, it appears prices have run far ahead of them, as this chart from FactSet illustrates. That suggests stocks are still rich, even if some share prices were cut down to size last week. Another metric that is often used by investors to the determine if shares are fairly valued is the Shiller P/E, which is based on average inflation-adjusted earnings over the previous 10 years. Shiller P/E is currently at 24.9, compared with the historical average of 16.5. By this metric, stocks are way overpriced. Pricey or not, though, stocks have their merits. Kristina Hooper, managing director of U.S. investment strategies at Allianz Global Investors, said stocks are more attractive now than they were before the pullback, especially if you are underexposed to stocks in your portfolio and your time horizon is long enough. “Considering alternatives, stocks still offer returns,” she added, warning that in the short term we will experience a lot more volatility, as global growth deceleration eventually translates into reduced earnings. Ned Davis Research crunched some numbers to see how valuations were correlated with returns and found that, on average, when markets are overvalued by 20%, their one-year return is negative 3.6% and their five-year return is flat. When they are undervalued by 20%, the one-year return is 19.4% and the five-year return is 65.3%. While we all would like to buy low and sell high, timing markets rarely works, since, in the long run, investors often miss out on opportunities. The problem with the stock market is not its lack of attractiveness but a scarcity of alternatives — and the cash on the sidelines. In a world of overvalued government bonds, plunging commodities and gold, and uncertainty in emerging markets, investors are finding very few havens in which to wait out rough times. Maybe that’s why the buy-the-dip mentality remains intact. By ANORA MAHMUDOVA REPORTER