CAPE, Tobin q, Imply Market Is 48% Overvalued

Tyler Durden's picture

A quick observation for those who care to see just how disconnected from rality the market is at these levels, comes courtesy of Smithers & Co., which has updated its CAPE (Cyclically Adjusted PE) and Tobin q chart. Briefly, as of June 10, the S&P was 46% overvalued based on CAPE and 50% overvalued based on q. Incidentally, this makes perfect sense: when the FNM and FRE churnamathons advised their HFT sponsors they would no longer be able to play hot potato with these two bankrupt stocks, they immediately dropped by 50% as soon as the HFT brigade exited stage left. It is not a stretch to see how the computerized trading brigade has made a comparable valuation anomaly with the broader market. Shut down HFT, and next thing you know the market will drop to its fair value: somewhere 50% lower.

From Smithers & Co:

With the publication of the Flow of Funds data up to 31st March 2010 (on 10th June 2010), we have updated our calculations for q and CAPE, which show very little change from our previous calculations.

Non-financial companies, including both quoted and unquoted, were 62%
overvalued according to q at 31st March 2010, when the S&P 500
index was 1169. Adjusting for the subsequent decline to 1087
(10th June, 2010), the overvaluation had fallen to 50%. Revisions to
data had little impact on q, with downward revision to net worth for Q4
2009 of 2.9% being offset by a downward revision to the market value of
non-financial equities of 2.1%. Net worth for Q1 2010 fell slightly as
equity buy-backs exceeded profit retentions.

The listed companies in the S&P 500 index, which include financials, were 58%
overvalued at 31st March 2010, according to our calculations for CAPE,
based on the data from Professor Robert Shiller’s website. Adjusting
for the subsequent decline to 1087 (10th June, 2010), the overvaluation
had fallen 46%. (It should be noted that we use geometric rather than
arithmetic means in our calculations.)

Data for our calculations of q are taken for 1900 to 1952 from Measures of Stock Market Value and Returns for the Non-financial Corporate Sector 1900 - 2002 by Stephen Wright, published in the Review of Income and Wealth (2004) and for 1952 to 2009 from the Flow of Funds Accounts
for the United States (“Z1”) published by the Federal Reserve. Data for
our calculations of CAPE are taken from the data published on Robert
Shiller’s website.

As net worth and cyclically adjusted earnings per share change little
during a quarter, only changes in share prices are important for
changes in the market value between our quarterly updates. The value of
the market can thus be readily adjusted by viewers to this website. As
the S&P 500 index changes, viewers can simply insert the new value
and calculate the q and CAPE values, i.e:

With the S&P 500 at 1169 as at 31st March 2010, q was 1.6166 and CAPE was 1.5761.

To update as at 10th June 2010, when the S&P 500 was 1087, for q take 1.61 × 1087 ÷ 1169 = 1.50 and for CAPE take 1.58 × 1087 ÷ 1169 = 1.46.