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.

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williambanzai7's picture

Market making or market fabricating?

ZeroPower's picture

Nice. Interesting data with CAPE, from what i understand.

As for Tobin's Q, very subjective, as firms marking-to-market aren't at par with firms marking-to-bullshit.

Pat Hand's picture

So, how bad would it be if book value resembled fair market value...?

VK's picture

Same as the Great Depression or worse, stocks down 90-95%.

Panafrican Funktron Robot's picture

As long as the wrong people can trade with money mainlined to them by the Fed, this will continue. 

Racer's picture

Another FED blown bubble! Who would have thought it

Rainman's picture

Damn sure smells like a Nasdaq decade coming soon. Somebody get a rope.

kreece's picture

Check the math as the drop would be 33%, not 50%

50% overvalued market = 1.50

Drop to fair value = 1.00

Drop % = 1.00/1.50 = .67 or 33% drop

33% is still a big number if you believe the premise 


VK's picture

Ummm, they state in their calculations that " (It should be noted that we use geometric rather than arithmetic means in our calculations.) ". So it is 50%.

RunningMan's picture

Does anyone have stats for whether the market ever traded at inflated valuations (as now) for extended periods of time? If liquidity via HFT is artificially driving equity prices up, there is no rule that prices revert unless the liquidity goes away. If this doesn't happen, we could stay at artificial valuations indefinitely, or at least until fundamentals come back in line in a decade or so. So back to the questions - (1) has liquidity ever been present in the market like this in the past, and if so, to what effect?, and (2) whats the longest the market has been out of line with CAPE and q metrics and what were those time periods?

Racer's picture

This is the mania of maths programmers instead of tulips or South Sea..

All the same... drive up  the prices based on nothing real and it always crashes.

This time the computers may cause the fastest flashiest crash ever and Oct 1987 was a mere dip by comparison

ZeroPower's picture

I suppose one can argue that, back then instead of the algos, MMs were the ones driving prices higher penny by penny, bit by bit, when they were the only ones in control of their respective stocks. But remember, just as easy as we've seen the computers can be turned off, the humans as well can easily refuse any bids that come their way. In 1987, guys on the floor simply closed their books and those that were providing liquidity were doing it at ridiculous spreads. So, not too different from our flash crash.

Implicit simplicit's picture

HFT and algos will make money driving  the downside just as they are doing it the upside now. They just care about making money. They probably can make a lot more in a shorter period of time when they decide to drive it down.

They will do that when there are no more shorts to squueze, but plenty of bulls to wipe out.

SteveNYC's picture

I agree. And if (as we know it is) it is math programmers determining the levitating value of equities, then we can safely assume that these geeks have no idea how to actually value a stock using such amazingly complex notions such as earnings multiples, and dividend payout ratios & yields.

I can't wait until these fuckers get their comeuppance. I want to see Ben go down with this ship too, oh yeah!

Rainman's picture

Answers to no.1 is no and 2 is NASDAQ 97-99 ( presently down 50% +/- from high for the past decade).

RunningMan's picture

Thanks Rainman. Seems like one issue is that the programmers are missing the point that their liquidity, if these metrics are valid, is now 'worth' half of the total market, but it is likely concentrated in the hands of a few large participants, and so this represents our new bubble. They presume that the value is real because they are forced into buying and selling the underlying assets in order to make money off the transactions. When that all heads south, kaboom (I think).

Thunder Dome's picture

Stock market needs same valuation as BP currently to be fairly valued.

Implicit simplicit's picture

Every once in a while I have mini epiphanies by looking at what has hppened and what is happening.

For instance, There is not much talk about Fannie and Freddie being delisted because the oil spill and the european potential deaults have taken center stage. The biggest prop of all RE has just sneakily admitted that the largest companies backing most of our mortgages is a blatant fraud.

 Meanwhile the stock market still trys to go up. What a fucking joke. The epiphany is the same one that I keep getting after each new crisis, except they are becoming more frequent, the stock market is going to crash sooner than later.

stickyfingers's picture

If all investing is, as Klarman said, mean reverting, then the market must be undervalued for a period of time. So maybe we will trade under book value for the S&P for a while.

RunningMan's picture

The massive amounts of liquidity created by the Fed/Treasury actions spilled into the market in a massive way early last year. They are aware that their actions had this impact. They don't know how to undo it without without driving the markets back down to their 'fair value' so they have done nothing. The so-called liquidity providers are simply in it to print as much money for themselves before the game ends not realizing it may destroy the currency and the country in the process (and the only alternative is unemployment, so either way their outcome is the same for them). IWe must find a way to put an end to this mania before they do us all in.

Cursive's picture

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.

I wonder what Kid Dynomite would say about this.

Ryan1053's picture

dont you think that FNM and FRE are cherry-picked examples to make a case. 2 subsidized companies, that have a real bettor-following on future survival--to my thinking--are not the same as, say, IBM with a real cashflow and sustainable balance sheet. I wouldnt extrapolate so far as saying all companies, on the average, should drop 50% without the betting community.

Is it fair valued. Shrug. Not for me to make a "claim" - but I dont agree with the example... or with the methodology for quantifying market fluff. 

Grand Supercycle's picture


EURO bullish warnings mentioned earlier, have strengthened today. Vice versa for the USD index of course.

I have detected EURO buying support for several weeks now.

XAUEUR daily chart gives bearish warnings as of today.

This could be an important development.

The proprietary indicators I use in my technical analysis can identify trend changes before they occur.

Menelaus's picture

Excellent Smithers!!! Release the hounds post-haste!!!