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Talking heads keep telling up the S&P 500 Index is overvalued based on current PE vs historical averages. (Not that talking heads are noted for their in depth analysis, but even stopped clocks are right twice a day.)

The Feb issue of Fidelity Outlook Magazine (p 13) shows a graph of the S&P 500 for the last 9 years overlayed with a plot of 1/(i.e. the reciprocal of) 10 yr Treasury yields. The plots are scaled and aligned to make it appear they correlate. “Finance theory suggests that interest rates influence valuations of companies because interest rates govern the present value of future earnings. . . . At current (interest rates), . . .the (S&P 500) is roughly 'fairly valued.'” I.e., historically low interest rates justify higher PE ratios for the S&P.

Other theories of why the S&P is worth more now than it used to be–

Fool Effect: TMF advises us to buy and hold S&P 500 Index funds regardless of what happens in the stock market. Perhaps rather than dumping their shares in a declining market, millions of Fools are following TMF recommendations and holding their shares.

Academy Award Effect: just as movies that win an Academy Award sell more tickets at the box office, S&P Index stocks are worth more simply because S&P selected them for inclusion in the index–more now than ever because index fund investing has gained popularity.

What do you think? Is the S&P 500 over valued or fairly valued and why?
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