In fact, based on six well-known and time-tested indicators, equities are more overvalued today than they’ve been between 69% and 89% of the past century’s bull-market tops.
To be sure, overvaluation doesn’t immediately doom a market. A year ago, the stock market was almost as overvalued as it is now, and it nevertheless turned in a decent year.
But valuation indicators’ inability to forecast the market’s short-term direction doesn’t justify ignoring them altogether. Their longer-term forecasting record is impressive, which means that — sooner or later — the market will succumb to their gravitational force.
Consider six widely used valuation indicators. To put their current readings into context, I compared them to where they stood at all bull-market tops since 1900 (using the definition employed by Ned Davis Research). Five of the six indicators show today’s market to be more overvalued than at between 82% and 89% of those previous peaks.
The price/book ratio, which stands at an estimated 2.6 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 28 major market tops since then, the price/book ratio was lower than it is today.
The price/sales ratio, which stands at an estimated 1.1 to 1. I was able to put my hands on per-share sales data back to the mid 1950s; at 16 of the 18 market tops since, the price/sales ratio was lower than where it stands now.
The dividend yield, which currently is 2.0% for the S&P 500. At 30 of the 35 bull-market peaks since 1900, the dividend yield was higher.
The cyclically adjusted price/earnings ratio, which currently stands at 26.8. This is the ratio championed by Yale University’s Robert Shiller. It was lower than where it is today at 30 of the 35 bull-market highs since 1900.
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 31 of the 35 bull-market tops since 1900.
The sixth valuation indicator is the one that is least bearish: The traditional price/earnings ratio. According to data on as-reported earnings compiled by Yale’s Shiller, and based on S&P estimates for the fourth quarter, this ratio currently stands at 18.7 to 1. It is higher than it was at 69% of past bull-market peaks.
No doubt many of you will try to wriggle out from underneath the bearish force of those ratios by nitpicking the assumptions behind this or that ratio. But notice that the six indicators are based on widely divergent approaches to valuation. You can find fault with this or that indicator, but that doesn’t help you very much since the remaining ones are telling much the same story.
To repeat, however, none of this immediately dooms the market. The market can stay overvalued for some time, and even become more overvalued.
Eventually, however, value wins out. Ben Inker, co-head of the asset-allocation team at Boston-based money management firm GMO, likens the market to a leaf in a hurricane, with the Earth representing the market’s underlying fundamental value:
“You have no idea where the leaf will be a minute or an hour from now,” he says. “But, eventually, gravity will win out, and it will land on the ground.”
http://www.marketwatch.com/story/the-stock-market-is-overvalued-any-way-you-look-at-it-2015-01-13
Realist - Everybody in America is soft, and hates conflict. The cure for this, both in politics and social life, is the same -- hardihood. Give them raw truth.
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