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Based on the latest S&P 500 monthly data, [my analyses indicate that] the market is overvalued somewhere in the range of 33% to 51%, depending on which of 4 indicators I used. This is an increase over the previous month’s 31% to 48% range. [Let me explain the details.] Words: 475
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
Short goes on to say, in part:
Here is a summary of the four market valuation indicators I updated at the beginning of the month:
- The Crestmont Research P/E Ratio (more)
- The cyclical P/E ratio using the trailing 10-year earnings as the divisor (more)
- The Q Ratio, which is the total price of the market divided by its replacement cost (more)
- The relationship of the S&P Composite price to a regression trendline (more)
To facilitate comparisons I adjusted the two P/E ratios and Q Ratio to their arithmetic means and the inflation-adjusted S&P Composite to its exponential regression. Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which I use as a surrogate for fair value.
Based on the latest S&P 500 monthly data, the market is overvalued somewhere in the range of 33 – 51%, depending on the indicator. This is an increase over the previous month’s 31 – 48% range.
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I’ve plotted the S&P regression data as an area chart type rather than a line to make the comparisons a bit easier to read. It also reinforces the difference between the line charts — which are simple ratios — and the regression series, which measures the distance from an exponential regression on a log chart.
Click to enlarge
The chart below differs from the one above in that the two valuation ratios (P/E and Q) are adjusted to their geometric mean rather than their arithmetic mean (which is what most people think of as the “average”). The geometric mean weights the central tendency of a series of numbers, thus calling attention to outliers. In my view, the first chart does a satisfactory job of illustrating these four approaches to market valuation, but I’ve included the geometric variant as an interesting alternative view for the two P/Es and Q.
In this chart the range of overvaluation would be in the range of 43 – 61%, an increase over last month’s 41% – 57%.
As I’ve frequently pointed out, these indicators aren’t useful as short-term signals of market direction. Periods of over- and under-valuation can last for many years but they can play a role in framing longer-term expectations of investment returns.
Conclusions
At the current low annualized inflation rate, and the extremely weak return on fixed income investments (Treasuries, CDs, etc.) the appeal of equities, despite overvaluation risk, is is not surprising however, at present, market overvaluation continues to suggest a cautious long-term outlook and guarded expectations.
*http://advisorperspectives.com/dshort/
Editor’s Note: The above post may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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