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Tags: stocks | overalue | market | cap | gnp

Stocks Overvalued Based on Ratios of Market Cap to GNP

Stocks Overvalued Based on Ratios of Market Cap to GNP
(iStock)

Dr. Edward Yardeni By Monday, 25 September 2017 02:31 PM Current | Bio | Archive

An “adynaton” is a figure of speech that is a hyperbole so extreme that it must be impossible.

A good example is: “That will happen when pigs fly!”

In effect, many of the most vocal bears were saying just that about the current bull market during its early years. Yet the bulls continue to fly.

The bull market in the S&P 500, which started on March 9, 2009, is now more than eight years old, with a gain of 270% through Friday’s close. That makes it the second best bull market since the start of the data in 1928.

Still in first place is the bull market from December 4, 1987 through March 24, 2000 with a gain of 582%. In current dollars, the market capitalization of the current bull market has flown well above the first-place holder.

Consider the following stats:

(1) Market capitalization. The Fed’s data, released last week through Q2, show that the value of all equities traded in the US rose by $28.9 trillion from Q1-2009 through Q2-2017, to a record $42.2 trillion (Fig. 1). From Q4-1987 through Q1-2000, this value rose by $17.5 trillion, to $20.2 trillion. Of course, on a percentage basis, it’s still no contest, with the current bull market’s market cap rising 216%, lagging the 646% recorded by the undisputed champ so far.

The market cap of the S&P 500 is up $15.5 trillion to $21.4 trillion during the current bull market through Friday’s close (Fig. 2).

(2) Valuation. The only bad news is that the Buffett Ratio, which is the market value of all equities traded in the US (excluding foreign issues) divided by nominal GNP, was 1.76, approaching its record high of 1.81 during Q1-2000 (Fig. 3). The comparable ratio for the S&P 500 (relative to S&P 500 revenues) was 2.00 during Q2, matching the previous record high during Q4-1999.

These ratios suggest that the bull might be flying too close to the sun and could suffer the same fate as the mythical Icarus. Then again, the situation appears less perilous when Joe and I compare the market value of all equities traded in the US (excluding foreign issues) to the after-tax profits reported along with GDP in the National Income and Product Accounts (NIPA). During Q2, the P/E ratios of the two were 19.2 using profits as reported to the IRS and 20.7 using profits from current production (a cash-flow measure) (Fig. 4). Those are relatively high P/Es for both of these series that start in 1952, but well below the peaks of around 35 for both during Q1-2000.

(3) Real earnings yield. Besides, as Joe and I observed last week, the real yield of the S&P 500 suggests that the index is fairly valued rather than overvalued. We calculated that by subtracting the CPI inflation rate (on a y/y basis) from the earnings-to-price (E/P) ratio of the S&P 500. During Q2, this measure of the real earnings yield was 2.6%, below the 3.3% average of this series since 1952. That’s a “fairly valued” reading for this measure, which typically falls closer to zero before bear markets (Fig. 5).

Our initial work on the S&P 500 real yield last Monday was inspired by our good friend John Apruzzese, the chief investment officer of Evercore Wealth Management. Today, let’s extend the analysis to calculating the E/P with the NIPA series for after-tax profits reported to the IRS as “E” and the market value of all stocks traded in the US (excluding foreign issues) as “P.” The real yield on this basis was 3.3% during Q2-2017, below its average of 4.9% since 1952 (Fig. 6). Again, readings closer to zero have been associated with bear markets in the past. The two measures of the real earnings yield are similar, though not the same, but neither is flashing warnings signals of significant overvaluation (Fig. 7).

(4) Tobin ratio. The Fed’s quarterly flow-of-funds database was also updated last week to show Tobin’s q, which is the ratio of the market value of equities to the net worth of corporations, including real estate and structures at market value and including equipment, intellectual property products, and inventories at replacement cost. In theory, when q is well above (below) 1.00, investors are paying too much (too little) for companies relative to their replacement cost (Fig. 8).

This ratio was 1.09 during Q2. Joe and I prefer adjusting the ratio so that its average is 1.00 since the start of the data in 1952. Doing so reveals an adjusted q of 1.51 during Q2. That’s relatively high, but well below the record high of 2.23 in this series during Q1-2000.

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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EdwardYardeni
The bull market in the S&P 500, which started on March 9, 2009, is now more than eight years old, with a gain of 270% through Friday’s close. That makes it the second best bull market since the start of the data in 1928.
stocks, overalue, market, cap, gnp
807
2017-31-25
Monday, 25 September 2017 02:31 PM
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