The stock market is overvalued, but that’s no reason to turn bearish, analyst says

Investors worried that the stock market is overvalued shouldn’t sell stocks, according to a Monday note from Piper Sandler.

The Wall Street firm’s portfolio strategy group, led by chief investment strategist Michael Kantrowitz, estimates the S&P 500 is overvalued by about 8%.

“So what?” Kantrowitz said of the overvaluation.

“An 8% over-valuation is no reason to get bearish. Stocks can remain at rich valuations as long as a ‘fear’ catalyst doesn’t arise from the usual suspects: interest rates, employment or inflation,” Kantrowitz said.

Without an imminent spike in interest rates, the unemployment rate, or inflation, the stock market should continue its upward trend even if it’s overvalued, according to Kantrowitz.

“Pretty much all valuation models have pointed to the market being expensive for quite some time. We always approach this from a catalyst perspective,” Kantrowitz told CNBC on Monday.

And with no negative catalysts on the horizon, Kantrowitz recommends that investors screen for stocks with strong earnings momentum when building their portfolios.

“It’s okay for equity markets to remain expensive, but I think investors really want to focus on stocks that have continued earnings momentum because those names will likely see the best outperformance and can hold those expensive multiples for longer,” Kantrowitz said.

Kantrowitz recommends investors monitor credit spreads to determine whether there is fear in the stock market that could signal a period of negative equity returns going forward.

And right now, they’re showing no signs of stress.

“Even despite both a close presidential election and a not-so-straightforward Fed meeting just a few weeks away, credit spreads on Friday reached new lows,” Kantrowitz said.

Tight credit spreads, a solid labor market, and continued GDP growth are all signals that investors should stay bullish, according to Kantrowitz, even if the stock market is slightly overvalued.