Fundamental Evaluation Series: S&P 500 valuation based on oil price

Defying pundits, the US benchmark stock index S&P 500 rose sharply after the Republican candidate Donald Trump secured victory in the November 8th election. Despite the recent correction, the stock index is up by almost 30 percent since the election result. S&P 500 is currently trading at 2752. The index is in its tenth year of Bull Run; hence some investors worry that it might be well overvalued. Here in this article, we would use oil price to measure S&P 500 valuations based on historical data.

• In our previous assessment last year, we saw that one unit of S&P 500 has brought about buying about 49 barrels of WTI oil and 46 barrels of Brent Crude. This measure suggested that S&P 500 is overvalued or the oil is undervalued by more than two-fold compared to history.

While this valuation is not certainly an indicator that the index might decline, but it strongly suggests that this ratio will be going through mean reversion at one point.

Our current calculations show that one unit of S&P500 is buying 40.8 barrels of WTI and 38.6 barrels of Brent. Historically speaking, one unit of S&P500 has bought around 23.1 barrels of crude. So, while the valuations have eased, the S&P500 is still overvalued or oil is undervalued and further mean reversion likely.