Today the market is out of whack again - except this time recent estimates of ROE are in the 21% range and AAA corporate bonds are trading near a 7% yield.
A study of a regression of the Dow's real prices shows a rising trend reflecting the fact that its inherent value increases over the long haul. Deviations form this trend identify, in retrospect, such undervaluations as the one which developed in the early 1980's and the overvaluation bubble of the late 1990's. While the regression line, which fluctuates as new data is incorporated, is not a proxy for intrinsic value, it does show clearly that market prices eventually revert to some long term "mean" or value.
In the long run, reversion to the mean is evident in many areas of the markets. Earnings, share prices, interest rates, currencies, commodities - they all fluctuate. As for the Dow, from this point forward, as the pendulum swings back to normal, one might reasonably expect either lower earnings or a rise in interest rates, possibly a combination of both.
From time to time wide differences between the Dow Index's intrinsic value and itsmarket price, or level, will develop resulting in serious mis-valuations. For those wishing to own stocks, these deviations from the norm should be seen either as investment opportunities or as signals to stand aside.
So, when Warren Buffett eschews today's equity markets as generally overpriced, I suspect he has come up with values in line with the above calculation.
John Di Tomasso
Di Tomasso Group Inc.
john@ditomassogroup.com
http://www.gold-eagle.com/article/what-dow-worth
| 
