The S&P 500 Index closed at a new record last Friday, which is no big deal since all-time highs have become ordinary occurrences lately.
But just how big is the bubble the market now finds itself in? The answer: the S&P 500 is probably 20 percent higher than it should be based on fundamentals — like the fundamental of corporate profits.
Here's how I came up with this number.
At Friday's close of 2,096.99, the S&P was trading at a forward-looking 17.3-to-1 price-to-earnings (PE) ratio. Explained simply, that 2,096.99 level was 17.3 times higher than the total expected 2015 per share earnings of the companies in the Index.
The average PE ratio for the S&P historically is only 13.8 times.
So, if the S&P were to drop back to its historical average, stock prices would decline 20.5 percent.
And, remember, if there is a rout in stocks (like has happened in the oil market) there's no guarantee that prices won't go lower than that. So a decline in stocks of greater than 20.5 percent isn't unlikely.
What's the good news? There's a decent chance that the Federal Reserve won't be able to raise interest rates this year. Despite the propaganda from Washington, the economy isn't very strong. So the Fed probably won't be able to make borrowing more expensive.
And without the Fed hiking rates, investors could still be enticed (forced?) into the stock market, despite the prospect of a collapse.
Could something else go right? Yes, corporate profits could rise. And if the E part equation improves, then PE ratios could become normal without stock prices going down.
But that doesn't seem to be the way 2015 is stacking up. According to Thomson Reuters, combined corporate profits will likely be horrible this year, declining by 2 percent if you include the disastrous results for oil companies.
Even when you exclude energy companies, earnings and revenue growth for S&P 500 companies will be modest.
So what am I getting at? I'm telling you to be careful putting any more of your hard-earned money into the stock market.
As they say in the casino business, if you can't afford to lose it then don't bet it.
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