The stock market is overvalued by almost every known metric.
The single best predictor of stock market performance is the cyclically adjusted price-to-earnings ratio or CAPE ratio. Most investors price a company based on its current Price to Earnings or P/E ratio. Essentially what you’re doing is comparing the price of the company today to its ability to produce earnings (cash).
However, corporate earnings are heavily influenced by the business cycle.
Typically the US experiences a boom and bust once every ten years or so. As such, companies will naturally have higher P/E’s at some points and lower P/E’s at other. This is based solely on the business cycle and nothing else.
CAPE adjusts for this by measuring the price of stocks against the average of ten years’ worth of earnings, adjusted for inflation. By doing this, it presents you with a clearer, more objective picture of a company’s ability to produce cash in any economic environment.
We have mentioned before that CAPE is the single most important metric for long-term investors. I wasn’t saying that for impact.
Based on a study completed Vanguard, CAPE was the single best metric for measuring future stock returns. Indeed, CAPE outperformed
1. P/E ratios
2. Government Debt/ GDP
3. Dividend yield
4. The Fed Model,
…and many other metrics used by investors to predict market value.
So what is CAPE telling us today?
The S&P 500 is currently at a CAPE of over 26.
The S&P 500 has only been at this level or higher a handful of times in the last 100 years. All of them have coincided with major market peaks.
This is not to say that the market has definitively topped or is about to Crash; but it does emphasize how overvalued the market is. Indeed, stocks are overvalued by just about every other metric you can imagine.
Warren Buffett’s favorite indicator for stocks (total market cap of stocks to GDP) is currently at its second highest level in 50 years with a reading of 125. The only higher reading the market has ever registered was in 2000 at the absolute peak of the Tech Bubble madness.
Other items that indicate the frothiness of the markets:
1) We are on track for $2.51 trillion in Mergers and Acquisitions this year. This will be the largest amount since 2007.
2) The stock market is currently sporting a Price to Sales of 1.7, even higher than it was at the peak of the Housing Bubble.
3) The average bull market going back to 1921 is 62 months long. This current bull market is now in its 64th month.
4) The VIX index (a measure of investor complacency or fear) is at an all time low. Investors today are even more complacent than they were in 2007 or 2000.
Suffice to say that of all the assets currently experiencing significant inflation, stocks are the biggest beneficiaries. They have been inflated to the point of being totally disconnected from reality.
This concludes this article. If you’re looking for the means of protecting your portfolio from the coming collapse, you can pick up a FREE investment report titled Protect Your Portfolio at http://phoenixcapitalmarketing.com/special-reports.html.
This report outlines a number of strategies you can implement to prepare yourself and your loved ones from the coming market carnage.
Phoenix Capital Research