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?
On October 12th, with the S&P 500 near its current
level, I wrote that the market was
overvalued by 16%. I based this on an analysis of the
cyclically adjusted P/E multiple (CAPE), which uses a moving
average of 10-year inflation-adjusted earnings.
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
qratio, 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 "
If stocks are overvalued to this degree
– and there is good reason to believe they
are -- investors should expect
mediocre long-term returns. Certainly, there is little
reason to expect permanently higher earnings growth (rather
the contrary) that would compensate for the CAPE's downward
reversion to its long-term average.
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
The breadth of market overvaluation in March 2000 was
extraordinary. Today, the U.S. market still contains some
pockets of value -- notably, high-quality companies, as
exemplified by the Dow Jones Industrial Average:
Dow Jones Industrial Average
Cyclically Adjusted P/E Multiple
(CAPE)
CAPE / CAPE Historical Average
March 2000 - Average
36.8
221%
September 2009 - Average
18.7
105%
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:
Stock
Price-to-Earnings Multiple
(Trailing-12-Months' Earnings) March 31,
2000
Price-to-Earnings Multiple
(Trailing-12-Months' Earnings) October 26,
2009
Procter & Gamble (NYSE: PG)
21.9
15.9
Microsoft (Nasdaq: MSFT)
67.3
18.6
Wal-Mart (NYSE: WMT) Continued... |