The S&P 500 index is trading at record high levels and optimism remains high with Barron's professional money manager survey indicating a record 74% money managers being bullish on markets even at current levels.
The PE ratio is one good measure of market valuation. The PEG ratio makes this measure complete as it takes future growth into consideration and measures valuations with respect to expected growth. For the S&P, the PEG ratio suggests overvaluation at current market levels. The chart below gives the PEG ratio for the S&P 500 index along with the PEG for the mid-cap and small-cap stocks. In general, a PEG ratio of over 1 indicates overvalued stocks or markets. Certainly, valuations are stretched at current levels.
It is also important to note that the PEG ratio has been calculated based on FY13 expected earnings of $107.55. I am of the opinion that earnings estimates might be just too optimistic. The actual earnings for FY12 was $86.5. It might be unrealistic to expect a 24% earnings growth in the current economic scenario. Therefore, if FY13 earnings estimates are revised downwards, the PEG ratio will indicate even more expensive markets.
The conclusion is to avoid fresh exposure to equities at these levels. Investors can consider booking profits and considering fresh exposure on corrections. I do expect equity markets to witness a meaningful correction over the next 3-6 months.