The Market Is 40% Overvaluedhttp://www.fool.com/investing/general/2009/10/28/the-market-is-40-overvalued.aspx Alex Dumortier, CFA
October 28, 2009
That's what economist Andrew Smithers wrote in his most recent report to clients. Dismissing this tidbit out of hand could be costly. In Valuing Wall Street, published in March 2000, Smithers warned investors that the U.S. stock market was dramatically overvalued; over the next three years, the S&P 500 lost more than 40% of its value. In an article published on March 23rd this year, Smithers told the Financial Times, "We're not a long way short from really, really good value." The rally off the March 9 low is evidence that his assessment was again correct.
40% overvalued -- based on what?
Smithers looked at the S&P 500's CAPE also, but some technical differences in his calculations lead him to conclude the degree of overvaluation is closer to 40%. Because he's spent a lot more time thinking about the CAPE than I have, I'll give him the benefit of the doubt. Furthermore, he finds that Tobin's q ratio, which compares the market value of equities against their net worth at replacement cost, highlights a similar level of overvaluation.
"Expensive markets give low returns"
Consequently, value-oriented asset manager GMO estimates that large-cap stocks will return just 2.3% after inflation over the next seven years ... less than half the long-term historical U.S. equity return (6.5%).
The difference between March 2000 and October 2009
Source: Author's calculations based on data from Dow Jones and Capital IQ, a division of Standard & Poor's.
A subset of stocks that were part of the index then and now tells the same story: