Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Micro Strategy Bubble Mania - 10th May 24
Biden's Bureau of Labor Statistics is Cooking Jobs Reports - 10th May 24
Bitcoin Price Swings Analysis - 9th May 24
Could Chinese Gold Be the Straw That Breaks the Dollar's Back? - 9th May 24
The Federal Reserve Is Broke! - 9th May 24
The Elliott Wave Crash Course - 9th May 24
Psychologically Prepared for Bitcoin Bull Market Bubble MANIA Rug Pull Corrections 2024 - 8th May 24
Why You Should Pay Attention to This Time-Tested Stock Market Indicator Now - 8th May 24
Copper: The India Factor - 8th May 24
Gold 2008 and 2022 All Over Again? Stocks, USDX - 8th May 24
Holocaust Survivor States Israel is Like Nazi Germany, The Fourth Reich - 8th May 24
Fourth Reich Invades Rafah Concentration Camp To Kill Palestinian Children - 8th May 24
Banxe Reviews: Revolutionising Financial Transactions with Innovative Solutions - 3rd May 24
MRNA - The beginning of the end of cancer? - 3rd May 24
The Future of Gaming: What's Coming Next? - 3rd May 24
What is A Split Capital Investment Trust? - 3rd May 24
AI Tech Stocks Earnings Season Stock Market Correction Opportunities - 29th Apr 24
The Federal Reserve's $34.5 Trillion Problem - 29th Apr 24
Inflation Still Runs Hot, Gold and Silver Prices Stabilize - 29th Apr 24
GOLD, OIL and WHEAT STOCKS - 29th Apr 24
Is Bitcoin Still an Asymmetric Opportunity? - 29th Apr 24
AI Tech Stocks Earnings Season Opportunities - 28th Apr 24
S&P Stock Market Detailed Trend Forecast Into End 2024 - 25th Apr 24
US Presidential Election Year Equity Performance in the Presence of an Inverted Yield Curve- 25th Apr 24
Stock Market "Bullish Buzz" Reaches Highest Level in 53 Years - 25th Apr 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Warning, The Stock Market Is Extremely Overvalued Right Now

Stock-Markets / Stock Index Trading Dec 10, 2009 - 12:25 AM GMT

By: DailyWealth


Best Financial Markets Analysis ArticleTom Dyson writes: Andrew Smithers is a world expert in stock market valuation...

Smithers is an "econometrician." He studies stock market statistics going back more than 100 years and creates indicators from these statistics to judge whether the stock market is cheap or expensive. His two favorite valuation indicators are named the "CAPE" and the "q."

CAPE stands for Cyclically Adjusted Price Earnings. You've heard of the price-to-earnings ratio. CAPE is like the P/E ratio, except it smoothes earnings over 10 years to take out the impact of booms and busts. CAPE data go back 127 years.

The q is a ratio of stock prices to asset values. You've heard of the price-to-book ratio. Book value is a company's "net worth" after you add up all the assets and subtract all the liabilities. The q is like the price-to-book ratio, except instead of book value, it uses the replacement cost of assets. Replacement cost is closer to reality than book value, as it reflects price inflation. Data for q go back to 1900.

In March 2000, Smithers and another economist, Stephen Wright, published a bestselling book titled Valuing Wall Street. In this book, they explained these indicators and used them to show the stock market was as much as 2.5 times overvalued at the end of 1998.

"The end of the twentieth century was almost certainly the very best time in the entire century to sell stocks," they concluded. The Nasdaq bubble collapsed the month their book arrived in bookstores.

Before the recent credit crunch, Smithers was sounding the alarm again...

In a January 2008 article, Smithers wrote, "Stock markets are vulnerable because they are overpriced... Investors should be aware that the downside potential for asset values looks far greater than the upside."

Right now, Smithers' indicators show the stock market is more than 40% overvalued. (At the most recent data point – September 17, 2009, when the S&P was at 1,069 – q showed the market was 41% overvalued and CAPE showed the market was 37% overvalued.)

At 40% overvalued, the market is the most overvalued it's ever been except for the peaks in 1929, 2000, and 2007.

"The S&P 500 is priced to deliver one of the weakest 10-year total returns in history except for the (ultimately disappointing) period since the mid-1990s," says Smithers.

To see a chart of the q and CAPE going back 100 years, click here.

Here's the thing that scares me: Smithers' ratios move like yo-yos around an average. Economists would call them "mean-reverting," meaning they bounce from overvalued to undervalued.

In 2000, both indicators hit extreme highs. Both were almost double the previous record stock-market overvaluation, recorded in 1929. This leads me to think we'll see extreme levels of undervaluation in these indicators at some point in the future.

If these indicators reach the same levels of undervaluation they hit at the market bottoms in 1921, 1932, 1949, or 1982, the S&P would need to fall to around 400...

In sum, you should be careful with the stock market right now. It's extremely overvalued from a historical perspective and there's the potential for a major decline in stock valuations over the next decade.

On the other hand, keep an eye on Smithers' chart. When the q and the CAPE fall below –0.4, this will be the moment to begin investing heavily in stocks again.

Good investing,


P.S. You should buy Smithers' book. It's one of the all-time great stock market books. I take it off my shelf at least four times a year. It's an easy read, written for the individual investor. You can find it on Amazon here. Or check out Smithers' website here.

The DailyWealth Investment Philosophy: In a nutshell, my investment philosophy is this: Buy things of extraordinary value at a time when nobody else wants them. Then sell when people are willing to pay any price. You see, at DailyWealth, we believe most investors take way too much risk. Our mission is to show you how to avoid risky investments, and how to avoid what the average investor is doing. I believe that you can make a lot of money – and do it safely – by simply doing the opposite of what is most popular.

Customer Service: 1-888-261-2693 – Copyright 2009 Stansberry & Associates Investment Research. All Rights Reserved. Protected by copyright laws of the United States and international treaties. This e-letter may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Stansberry & Associates Investment Research, LLC. 1217 Saint Paul Street, Baltimore MD 21202

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Daily Wealth Archive

© 2005-2022 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in