ReSolve Asset Management analysts lay 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.
Shiller CAPE Ratio: The Shiller CAPE Ratio (25.56) is perhaps the best known of these four market indicators. With a value currently above 25 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 (0.95) 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 (115.2%). 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 115% this third indicator is also showing the market is over-valued. This does not mean it will not go higher. However, the odds are stacked in favor of a bear market, not a bull market.
Price Regression To S&P 500 Trend: The fourth indicator 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.