Critical Metrics Signal Market Warnings
Back in March of 2016 I wrote a blog presenting data related to an over-bought market at that time. Today’s post (Part 2) is an update and review of that information. U.S. Equities have not cooled off since March of 2009. The following data from ReSolve Asset Management analysts lays out four reasons why the stock market is over-valued. As investors, we need to pay attention to these long-term indicators. The links below provide quick access to the numerical values backing the high valuation of the current market. These values will slowly change over time so we need to be vigilant as new data becomes available. Most of this information comes from that 2016 post, but with updated figures. Here are the four critical market factors with data from a little over a year ago to what it is today.
Shiller CAPE Ratio: The Shiller CAPE Ratio (Was 25.56 – Now is 29.48) is perhaps the best known of these four market indicators. With a value currently above 29 the CAPE is well above its average of 16 to 17. Note from the graph what a buying opportunity the market was in 1982. Many of us were able to take advantage of the low market value as the DJI was around 780 in August of 1982. The Shiller CAPE is one long-range indicator to watch.
Q-Ratio: The Q-Ratio (Was 0.95 – Now is 1.06) is the measure of the market value of a company divided by its replacement cost. How expensive are stocks relative to the replacement value of the corporate assets. Look at the level in 1982. Here is another definition of the Q-Ratio.
Market Capitalization vs. GNP: This article by Jill Mislinski includes a graph showing the Market Cap vs. GNP (Was 115.2% – Now is 133.2%). This is one of Warren Buffett’s favorite broad market indicators. Advisor Perspectives is one of my highly ranked Bookmarks and you will find it listed in the right-hand side bar. At 133% this third indicator is also showing the market is over-valued. As this metric, and any of the other four go higher, the greater the risk to individual investors.
Price Regression To S&P 500 Trend: The fourth indicator (Was 91% – Now is 97%) examines the pricing trend vs. the S&P 500 trend. Check the graph in this link showing the long-term price trend of the S&P 500. Note the 1966 and 1982 dates as well as the more recent inflection points. This fourth indicator is a reflection of what is going on in the prior three indicators.
If we take the above four indicators as warning signals and combine it with the Nasty Mathematics of Volatility, we need to be on constant guard to protect capital as we devote more attention to portfolio risk.
It is not my intention to become a complete “Eor.” Neither does it make sense to hide from the facts. So – what does one do with this information. My recommendation is to use the Kipling spreadsheet with care. Monitor the two key sell rules. Once more, they are as follows.
- Sell if the security is performing below SHY.
- Sell if the security is priced below its 195-Day EMA.
Pay attention to the Position Sizing worksheet found in the Kipling and if risk-averse, set stop limit orders. Based on the above four metrics, it is time to be vigilant and protect capital.