Is the market too hot? Yardeni weighs risks of correction or worse

Investing.com -- The U.S. stock market may be flashing signs of excessive valuation, raising questions about whether another correction, or worse, is imminent, according to Yardeni Research.

In a note Friday, Yardeni pointed to the “plenty of [exuberance] visible in the quarterly Buffett Ratio,” which compares the total market value of U.S. corporate equities to nominal GDP. 

The firm explained that a weekly proxy for the metric, the S&P 500 index divided by forward revenues per share, reached 3.03 in the week of July 9, matching its level just before the last correction began in February.

Yardeni observed that while confidence remains muted, “there doesn’t seem to be much roaring… in measures of consumer and business confidence.” and equity valuations are another story. 

“So is the stock market irrationally exuberant and set for another fall, i.e., a correction or even a bear market?” the note asked.

Yardeni believes the answer depends on whether the next crisis sparks another round of recession fears or an actual downturn. 

“Corrections happen when recession fears depress the valuation multiple… Bear markets occur when recession fears accurately anticipate an economic downturn,” Yardeni explained.

So far, however, economic resilience has supported valuations. “We reckon that the Buffett Ratio, as well as other stock market valuation measures, have rebounded to where they were before the latest correction because investors have more confidence in the resilience of the economy,” the analysts wrote.

They added that the economy’s durability has helped drive the continued outperformance of the “Magnificent-7,” and that “the longer that the economy is expected to grow, the higher is likely to be the Buffett Ratio and the P/E multiple.”

Yardeni believes its Roaring 2020s thesis remains intact, for now.