The Stock Market Is Overvalued, No Matter How You Measure It

My Comments: Some of you will think I’m an alarmist. And perhaps I am. But the signals that have been present for some 18 months are getting louder, much louder.

I’ve not included all the charts that appeared with this article as there are too many of them and they are all negative. Here’s a link to the article itself:  You should know I don’t have the talent to do this on my own.

Perhaps I’ll find some good news to share with all of you later this week. I hope so, because it’s on us to be prepared and avoid the inevitable mess.

• The US stock market remains overvalued relative to the broader economy.
• We have reached the limits of monetary policy, and it is now time for fiscal policy makers to act.
• Over indebtedness continues to be the problem and de-leveraging the solution.

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.” – Charles Mackay, Author, Extraordinary Popular Delusions and the Madness of Crowds

I believe investors would be wise to exert caution at this time in the economic cycle. We have seen the (NYSEARCA:SPY) market rally some 187.74% from the 2009 lows, and market levels are now overvalued by virtually every metric. In my previous piece “5 Themes for 2015”, I articulated the likelihood that indexers will be outperformed by stock pickers this year. This is because I believe the market is extremely overvalued on the whole, and investors need to be selective about what they own. There are parts of the market that remain undervalued as I have previously highlighted. But on the whole, stock indexes are overvalued when viewed using many different measurement methods as seen in the chart above:

Yes…This Is a Stock Market Bubble
Any who contends that we are not in the midst of a stock market bubble is ignoring the truth of the economic and historical financial data we have available. Many believe that the market can continue to push higher, and indeed we may see additional advancement in equity indexes, on account of capital coming in from overseas and investors continuing to search for yield in a low yield world. Ultimately, I believe this will only make the ending of this market cycle that much more severe.

I continue to believe that the macro-economic situation points investors to the Long-Term Zero Coupon U.S. Treasury market as a stable port in the deflationary storm. The marginal gains that may be had from any potential upside in equity markets pale in comparison to the enormous draw down that I believe will eventually occur.

It’s Different This Time
Investors continue to articulate the old adage “It’s different this time.” They are right, in the sense that we are in unknown waters with the Federal Reserve’s extraordinary monetary policy, but the lessons of financial history have a way of repeating themselves, and reminding us it is not, in fact, different this time.

The Federal Reserve has expanded the balance sheet to over $4 trillion, and yet we continue to see lack luster velocity and inflation below the Fed’s target rate, illustrating the strength of deflationary forces. The US is in danger of entering into a Japanese-style deflationary trap where there is no escape from QE, and higher GDP growth rates continue to elude us, necessitating more QE. This cycle in danger of continuing for some time, until we realize that debt is the problem and deleveraging is the only solution, painful as it may be.

Future stock market returns will likely be in the low single digits as a result of this QE influenced market rally, which we can see in the P/E 10 at 26.52. The Fed’s extraordinary monetary policy has proven disastrous to savers, and has created a stock market built primarily on financial engineering and excess liquidity in the banking system, demonstrating that economic policy and investment policy are not always aligned.

I believe that caution is warranted, as it is completely plausible to see a significant downward move in the market at a magnitude larger than any one sees coming. Most down trends come with little warning, and investors are left asking “What happened?” Current equity market valuations are not supported by the economic data. The US has only 2.5% GDP growth in the first three quarters of 2014, there is subdued wage growth, and bubbles in lending fueling consumer spending, and excess leverage, fueling stock speculation. With equity markets at all time highs and Main Street continuing to suffer, the bond market continues to predict the coming storm.

With No Wage Growth, Debt Takes the Place of Income
The United States economy has not shown a change in the real median household income for nearly twenty years.

The economy continues to show a lack of true wage growth. Feeling the lack of income growth, consumers are resorting to adding additional debt to their balance sheets, reversing a healthy period of deleveraging after the financial crisis. Consumption today, financed by debt, means lower consumption in the future. Positive economic growth cannot be fueled by mounting debt burdens.

Globally, debt levels have reached unsustainable levels in both the public and private spheres. In a previous piece, I talked about the deleterious role over indebtedness can play in stifling economic growth. Moving forward, I see these trends playing out over a long time horizon that will likely leave the Fed on hold in raising rates, and will see the long-term US treasury yields continue to ratchet lower. Velocity continues to remain weak, as do wages, the PCE, and other measures of economic health. Perceived strength in the employment situation is really driven by decreases in the labor force participation rate. The economy is hardly healthy, despite the continued rise in equity prices to lofty levels.

The put created by excessive QE has driven margin debt to an all time high and created the same environment that was the catalyst for the financial crisis, over indebtedness.

The solutions to the challenges we face are not easy, and the responsibility does not rest solely with the Federal Reserve. I believe we have reached the limits of what can be achieved through monetary policy. The toxic effects of over indebtedness continue to plague real GDP growth, thus it is now time for fiscal policy makers to work together for the good of the country, and to put the nation on sound financial ground.

Given this reality and the case I made here, I continue to hold a portfolio predominantly composed of the US Dollar, (NYSEARCA:ZROZ) 30-Year Zero Coupon US Treasury Bonds and Swaps, and a focused group of select, undervalued equity securities. I believe this portfolio strategy can continue to outperform benchmarks in this slow-growth world that will characterize the global economy for some time.