by James Quinn
Keep ignoring John
Hussman, Robert Shiller, Jeremy Grantham, and all the other data
oriented people who honestly assess the stock market and are positive we
are in for a big fall. The market is so overvalued at this point that
it won’t even need an external event to trigger a crash. Gravity always
wins in the end.
Opinion: Being a stock-market bull just got a lot harder
The U.S. is overvalued when using many different metrics
Reuters
London (MarketWatch) — Making the bullish case is getting a lot harder.
Let’s say that you want to
wriggle out from underneath the bearish conclusions of the cyclically
adjusted price-to-earnings ratio (CAPE), which for some time now has
been very bearish. Sidestepping that conclusion turns out to be a lot
harder than you think.
The CAPE is the version of the
traditional P/E ratio that has been championed by Yale University
finance professor (and recent Nobel laureate) Robert Shiller. Currently,
for example, the CAPE stands at 25.69, which is 55% higher than its
average back to the late 1800s of 16.55 and 61% higher than the ratio’s
median level of 15.95. In fact, there have been only three times since
the 1880s when the CAPE has been higher than where it stands today:
1929, 2000 and 2007 — all three of which, of course, coincided with
major market highs.
The CAPE isn’t a perfect
indicator, as Shiller himself will tell you. There are legitimate
reasons to question its approach to market valuation. In addition, the
bulls have shamelessly come up with myriad other “reasons” not to pay
attention to it.
But Mebane Faber, chief investment officer at Cambria Investment
Management, has this to say to all these so-called CAPE haters: “Fine,
don’t use it. Let’s substitute in book and cash flows, two totally
different metrics.”
Unfortunately for the bulls,
the conclusion of looking at the market from those alternate
perspectives is almost identically bearish.
Courtesy of data from Ned Davis Research, Faber ranked 43 countries’ stock
markets around the world according to their relative valuations
according to the CAPE as well as to cyclically adjusted ratios of
price-to-book, price-to-cash flow, and price-to-dividend. When ranked
according to the CAPE, for example, with top ranking going to the most
undervalued country’s stock market, the U.S. is in 41st place. Only two countries are more overvalued according to this indicator.
| Indicator | US market’s rank out of 43 countries, with #1 being most undervalued |
| CAPE | 41 |
| Cyclically-adjusted price-to-book ratio | 37 |
| Cyclically-adjusted price-to-dividend ratio | 39 |
| Cycilcally-adjusted price-to-cash-flows ratio | 36 |
The accompanying table shows
where the U.S. market would rank according to the other three
indicators. Notice that ignoring the CAPE doesn’t get the bulls very
far.
To argue that the U.S. stock
market isn’t overvalued, in other words, the bulls not only have to
dismiss the CAPE but also argue why the U.S. market should be priced so
richly relative to book value, cash flows and dividends.
That’s not necessarily impossible. But it is clear that the bulls have a lot more work cut out for them.
Furthermore, even if the
bearish conclusions of these diverse indicators turn out to be right,
you should know that they are long-term indicators, telling you very
little about the market’s near-term direction. My favorite analogy to
describe the situation comes from Ben Inker, co-head of the
asset-allocation team at Boston-based money management firm GMO.
He likens the market to a leaf
in a hurricane: “You have no idea where the leaf will be a minute or an
hour from now,” he says. “But eventually gravity will win out and it
will land on the ground.”
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