Sunday , 17 December 2017


Current Market Overvaluation (from 33% – 51%!) Suggests Cautious Long-term Outlook

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

So says Doug Short, vice president of research at Advisor Perspectives (http://advisorperspectives.com/dshort) in edited excerpts from his original article* entitled The Market Is Now Between 33% And 51% Overvalued.
 Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and 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:

  1. The Crestmont Research P/E Ratio (more)
  2. The cyclical P/E ratio using the trailing 10-year earnings as the divisor  (more)
  3. The Q Ratio, which is the total price of the market divided by its  replacement cost (more)
  4. 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

image

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%.

image

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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