Here’s How You Know The Stock Market Is Hugely Overvalued

roller coaster2My Comments: Worrying about your money is a normal activity. At least it is for me.

That being said, to the extent you have money somewhere where your principal is not guaranteed, I think there is a high probability you will soon suffer some losses.

Actually, unless you sell at a loss, you really haven’t ‘lost’ anything. But if your account value drops, and you are old like I am, you may not have the necessary time to wait for it to recover. That’s because you may be using it to pay your bills, and chances are those bills will continue. Unless of course you die, which means it becomes someone else’s problem.

Mark Hulbert – August 16, 2016

The U.S. stock market currently is more overvalued than it was at almost every bull market peak over the past 100 years.

That’s crucial, since it undercuts one of the arguments some exuberant investors currently are using to try to wriggle out from underneath the otherwise bearish message of various valuation indicators. Their argument in effect is “of course current valuation is high; what would you expect when the market is at an all-time high?”

Unfortunately, an equally sobering picture is painted when we compare the current market not to historical averages but to just those past occasions when equities were at the top of a bull market.

In fact, as you can see from the chart (not shown), the current stock market is more overvalued, in terms of the following metrics, than it was at most of the past bull market peaks dating back to 1900.

Giving credence to this message is that it comes from six different ways of measuring valuation. That should make it harder for the bulls to dismiss the data:
1. The price/book ratio, which stands at 2.8 to 1: The book value dataset I was able to obtain extends only back to the 1920s rather than to the beginning of the century, but at 23 of the 29 major market tops since then, the price/book ratio was lower than it is today.

2. The price/sales ratio, which stands at an estimated 1.9 to 1: I was able to access per-share sales data back to the mid 1950s; at 18 of the 19 market tops since, the price/sales ratio was lower than where it stands now.

3. The dividend yield, which currently is 2.1% for the S&P 500: SPX, -0.33% . At 31 of the 36 bull-market peaks since 1900, the dividend yield was higher. (high is good; low is bad)

4. The cyclically adjusted price/earnings ratio, which currently stands at 27.2: This is the ratio championed by Yale University’s Robert Shiller. It was lower than where it is today at 31 of the 36 bull-market highs since 1900.

5. The so-called “q” ratio: Based on research conducted by the late James Tobin, the 1981 Nobel laureate in economics, the ratio is calculated by dividing market value by the replacement cost of assets. According to data compiled by Stephen Wright, an economics professor at the University of London, and Andrew Smithers, founder of the U.K.-based economics-consulting firm Smithers & Co., the market currently is more overvalued than it was at 30 of the 36 bull-market tops since 1900.

6. P/E ratio: This is the valuation indicator that is perhaps most-often quoted in the financial media. Nevertheless, according to data on as-reported earnings compiled by Yale’s Shiller, and based on S&P estimates for the second quarter, this ratio currently stands at 25.2 to 1. That’s higher than at 89% of past bull-market peaks.

To be sure, valuation indicators are not helpful guides to the market’s shorter-term direction. Overvalued markets can stay overvalued for some time, and even become more overvalued. But value eventually wins out.

For example, it was in December 1996 that Yale’s Professor Shiller gave his now-famous lecture to the Federal Reserve about irrational exuberance. His analysis struck many as silly during the subsequent three years in which stocks continued to soar; when the dot-com bubble hit he looked like a genius — and he eventually was awarded the Nobel prize.

A timely analogy comes from Ben Inker, co-head of the asset-allocation team at Boston-based money management firm GMO. He likens the market to a leaf in a hurricane: “You have no idea where the leaf will be a minute or an hour from now. But eventually gravity will win out and it will land on the ground.”

So enjoy the market’s strength — while it lasts.

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