The S&P 500 is considerably overvalued – somewhere in the range of 34% to 61% – depending on which of 4 market valuation indicators are used and whether the valuation is based on the arithmetric or geometric mean of each. While these findings are not useful as short-term signals of market direction…they play a role in framing longer-term expectations of investment returns and suggest a cautious outlook and guarded expectations. [Here are the details.] Words: 676
So says Doug Short (www.dshort.com) in excerpts from an article* which Lorimer Wilson, editor of www.munKNEE.com (It’s all about Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. Short goes on to say:
The 4 market valuation indicators I follow and are used in this analysis are:
- 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 to a regression trendline (more)
The chart below – which 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”) – shows the range of overvaluation of the S&P 500 somewhere in the range of 40% to 61%. The geometric mean weights the central tendency of a series of numbers, thus calling attention to outliers.
Who in the world is currently reading this article along with you? Click here to find out.
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 ratio.
The above indicators aren’t useful as short-term signals of market direction – periods of over and under valuation can last for years – but they can play a role in framing longer-term expectations of investment returns. At present they suggest a cautious long-term outlook and guarded expectations.
- Market Crash Will Hit By Christmas 2011! Here’s Why https://www.munknee.com/2011/07/the-sp-500-is-worth-only-910-get-out-or-lose-big/
- S&P 500 Likely To Top Out at 1400 – 1500 & Then Topple to 400! Here’s Why https://www.munknee.com/2011/02/uncanny-relationship-with-nikkei-1929-crash-suggests-sp-500-about-to-top-out-and-then-tumble/
- P/E Ratio of S&P 500 at 9 Month Low! Is It Time to Buy? https://www.munknee.com/2011/06/pe-ratio-of-sp-500-at-9-month-low-is-it-time-to-buy/
- Will a Black Swan Event Cause the S&P 500 to Drop by 40%? https://www.munknee.com/2011/06/will-a-black-swan-event-cause-the-sp-500-to-drop-by-40/
- Stock Market is Due for a 15-20% Correction – Here’s Why https://www.munknee.com/2011/06/stock-market-is-due-for-a-15-20-correction-heres-why/
- A Violent Correction Is Coming For the S&P 500! Here’s Why https://www.munknee.com/2011/06/a-violent-correction-is-coming-for-the-sp-500-heres-why/
- Why a Major Stock Market Correction is Imminent https://www.munknee.com/2011/05/why-and-how-best-to-play-a-major-stock-market-correction-is-imminent/
- S&P 500 is 45% Overvalued According to Reversion to Mean Analysis! https://www.munknee.com/2011/01/these-2-historical-charts-show-how-high-then-how-low-the-sp-500-might-go/
- How Mean Will the S&P 500′s Future Regression to Trend Be? https://www.munknee.com/2011/01/how-mean-will-the-sp-500s-future-regression-to-trend-be/
- Surprise! Limited Downside Risk Exists In S&P 500 https://www.munknee.com/2011/06/surprise-limited-downside-risk-exists-in-sp-500/
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
- Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.