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The Stock Market Is Overvalued Between 48% And 61%
TBI - Doug Short.Com ^ | 6-2-2011 | Doug Short

Posted on 07/02/2011 4:31:36 PM PDT by blam

The Stock Market Is Overvalued Between 48% And 61%

Doug Short, DShort.com
Jul. 2, 2011, 8:16 AM

The Q Ratio is a popular method of estimating the fair value of the stock market developed by Nobel Laureate James Tobin. It's a fairly simple concept, but laborious to calculate. The Q Ratio is the total price of the market divided by the replacement cost of all its companies. Fortunately, the government does the work of accumulating the data for the calculation. The numbers are supplied in the Federal Reserve Z.1 Flow of Funds Accounts of the United States, which is released quarterly.

The first chart shows Q Ratio from 1900 to the present. I've estimated the ratio since the latest Fed data (through 2011 Q1) based on a combination of the price of VTI, the Vanguard Total Market ETF, and an extrapolation of the Z.1 data itself.

Interpreting the Ratio

The data since 1945 is a simple calculation using data from the Federal Reserve Z.1 Statistical Release, section B.102., Balance Sheet and Reconciliation Tables for Nonfinancial Corporate Business. Specifically it is the ratio of Line 35 (Market Value) divided by Line 32 (Replacement Cost). It might seem logical that fair value would be a 1:1 ratio. But that has not historically been the case. The explanation, according to Smithers & Co. (more about them later) is that "the replacement cost of company assets is overstated. This is because the long-term real return on corporate equity, according to the published data, is only 4.8%, while the long-term real return to investors is around 6.0%. Over the long-term and in equilibrium, the two must be the same."

(snip)

(snip)

TOPICS: News/Current Events
KEYWORDS: djia; economy; investing; markets

1 posted on 07/02/2011 4:31:40 PM PDT by blam

To: blam

As a former stockbroker, I never, and still don’t know why the market went up during this Obamination administration.

2 posted on 07/02/2011 4:33:52 PM PDT by RacerX1128

To: RacerX1128

What, the fed, the fed, they were lending money to buy stock. They thought the stock market value set the economy, they were wrong as usual.

3 posted on 07/02/2011 4:37:53 PM PDT by org.whodat

To: RacerX1128

More buy orders then sell orders? Of course, the buy orders came from QEII and not the general public, but up is up. Right?

4 posted on 07/02/2011 4:38:13 PM PDT by Wingy (Don't blame me. I voted for the chick. I hope to do so again.)

To: blam

Although this guy may have somewhat of a point, I disagree with his estimation that at the low (6626.9) in 2009, the market was only 7% undervalued. This makes me question his numbers. IMO

5 posted on 07/02/2011 4:45:39 PM PDT by Racer1

To: blam

If you plot the slope of the stretch between the third and forth kink of the sheep’s entrails the reason for the market valuation becomes very clear

6 posted on 07/02/2011 4:52:57 PM PDT by bert (K.E. N.P. N.C. D.E. +12 ....( History is a process, not an event ))

To: RacerX1128
As a former stockbroker, I never, and still don’t know why the market went up during this Obamination administration.

It went up because of the Fed's money printing. It was only a nominal increase. Real value has probably declined.

7 posted on 07/02/2011 5:02:30 PM PDT by SeeSharp

To: RacerX1128

My .02:

The primary reason it went up was because it had been massively smashed, down to SP 666 Mar 09, 2009. As I’m sure I don’t have to explain to you, this was a crash of multi-generational proportions. Perhaps it was deserved, but I think most would agree it was waaaaay overdone, perhaps properly reflective of of credit conditions around that time. But those have since healed, to a large extent.

The Fed and Tsy demonstrated that they were available to backstop the near-infinite but certainly unquantifiable black holes created in bank balance sheets and more publicly, equities around that time.

That was truly an “end of the world” event; which one really cannot bet on. Because a: by definition, it only happens once. b: if you win, there’s nobody to pay off your winning bet.

I will agree with you in the sense that the rally off those lows is perhaps a once in 2-generation event. One does not need to look too hard to find triples, quadruples, octuples in common names such as DOW, CAT, HIG, PRU, many others.

But IMO, the greatest reason for the rise in the market is that there simply is no other readily accesible place to put money that offers a ROI.

The valuations and certainly the liquidity are largely illusions. But nobody knows better than the Fed that the US economy is primarily influenced by green closes on the DJIA on the 6 o’clock news.

8 posted on 07/02/2011 5:07:11 PM PDT by Attention Surplus Disorder (Tired of being seen as idiots, the American people went to the polls in 2008 and removed all doubt.)

To: Attention Surplus Disorder

“The primary reason it went up was because it had been massively smashed, down to SP 666 Mar 09, 2009. As I’m sure I don’t have to explain to you, this was a crash of multi-generational proportions. Perhaps it was deserved, but I think most would agree it was waaaaay overdone, perhaps properly reflective of of credit conditions around that time. But those have since healed, to a large extent.”

If the chart on this thread has any meaning, the 666 value was a reversion to just below the mean.

9 posted on 07/02/2011 5:14:08 PM PDT by ModelBreaker

To: bert
If you plot the slope of the stretch between the third and forth kink of the sheep’s entrails the reason for the market valuation becomes very clear

LOL! I think we have the same stock broker!

10 posted on 07/02/2011 5:24:08 PM PDT by central_va ( I won't be reconstructed and I do not give a damn.)

To: RacerX1128
As a former stockbroker, I never, and still don’t know why the market went up during this Obamination administration.

As a former stock broker, you should know. Some companies have bulging balance sheets. Profits are up. Orders are backlogged.

11 posted on 07/02/2011 5:24:56 PM PDT by BipolarBob (Beer? That's the reason I get up in the afternoon.)

To: RacerX1128

And that’s why you’re a “former” broker. :-b

(come on, it was tee’d up and ready to clobber)

12 posted on 07/02/2011 5:34:53 PM PDT by muleskinner

To: RacerX1128

Well:

1. Grossly oversold condition in March 2009, well below fair market value.

2. Increased corporate profits and cash flow.

3. Low interest-rate environment where dividends are high than bond interest.

4. Biggest factor of all, the gradual realization that Obama and the Democrats are digging their own grave.

13 posted on 07/02/2011 6:25:35 PM PDT by proxy_user

To: RacerX1128

>> As a former stockbroker, I never, and still don’t know why the market went up during this Obamination administration.

That’s quite simple. If you look at technical analysis, the market has gone up in exact inverse relationship to the decline of the dollar, which has been caused by the actions of the Bracky regime and the Fed. It’s kind of a phony rally, basically.

14 posted on 07/02/2011 6:44:09 PM PDT by Babu

To: Babu
There's much to note about that thesis. (lower dollar = higher stocks) I have made that point myself.

1 year:

2 years:

15 posted on 07/02/2011 6:54:51 PM PDT by Attention Surplus Disorder (Tired of being seen as idiots, the American people went to the polls in 2008 and removed all doubt.)

To: Attention Surplus Disorder

There ya go. As anyone can see, vis a vis the charts, the relationship between the dollar and the stock market is close to exactly inverse.

16 posted on 07/02/2011 7:09:31 PM PDT by Babu

To: org.whodat

I’ve heard people say that QE1 and QE2 were the training wheels our markets needed to get back on track. Actually QE1 and 2 now ARE the markets. It’s as simple as that. Money printing to make the markets look good but completely destroy the dollar and economy. Pure lunacy.

17 posted on 07/02/2011 7:18:22 PM PDT by wolfman

To: org.whodat

I’ve heard people say that QE1 and QE2 were the training wheels our markets needed to get back on track. Actually QE1 and 2 now ARE the markets. It’s as simple as that. Money printing to make the markets look good but completely destroy the dollar and economy. Pure lunacy.

18 posted on 07/02/2011 7:19:30 PM PDT by wolfman

To: wolfman
Money printing to make the markets look good but completely destroy the dollar and economy. Pure lunacy.

Now we're really screwed. The longer you kick the can down the road, the more the pain.

19 posted on 07/02/2011 7:29:12 PM PDT by BipolarBob (Beer? That's the reason I get up in the afternoon.)

To: blam

Pump, pump, pump, pump.....

20 posted on 07/02/2011 7:37:26 PM PDT by Iron Munro (The more effeminate & debauched the people, the more they are fitted for a tyrannical government.)

To: blam

I think it is fixed by the Fed, Goldman Sachs, and a lot of the other biggies. In a couple of years, all those 401k proceeds are going to be cashed in and you’ll see a drop like no other. The Fed is causing money to be printed, Goldman Sachs and the crew are doing dummy trades to push up prices and commissions, and most of the corporations are being looted of cash by the managers and directors.

21 posted on 07/02/2011 7:39:09 PM PDT by RetiredTexasVet (There's a pill for just about everything ... except stupid!)

To: wolfman
The sole reason for QE1 and QE2 was to fund government. The stock market had nothing to do with it. If Bernanke sticks to his guns and doesn't offer QE3, then the federal government will be hard pressed to come up with the additional \$1.6 trillion it will need to continue functioning at current levels. So even if the debt ceiling is raised, the Treasury won't be able to find enough lenders to cover that amount. Next, we will see interest rates rise rapidly in order to attract the dollars the Fed has been supplying for the past 2½ years.

As for the stock market, it is simply a matter of supply and demand. When stocks are in demand, prices go up. When demand falls, so do prices. Anyone with dollars is looking for some place to put them, and with real estate on the decline and new business ventures being taxed out the wazoo, the stock market becomes a better option. So more people invest, and prices rise.

22 posted on 07/02/2011 7:43:13 PM PDT by Hoodat (Yet in all these things we are more than conquerors through Him who loved us. - (Rom 8:37))

To: Babu

I am, however, detecting early signs that this inverse relationship may be breaking down....so beware of relying on this as a “black box” type of thing. It has worked remarkably, insanely well for 2 years. By the way, there is little or no secret about it, either.

I’m not saying that the relationship will vanish; I am saying it may not be *by far* the most significant driver of stock prices which it has been. I suspect a weakening dollar, when it happens in compressed time periods will be decidedly bullish for equities for the foreseeable future, under almost any circumstances.

23 posted on 07/02/2011 8:06:56 PM PDT by Attention Surplus Disorder (Tired of being seen as idiots, the American people went to the polls in 2008 and removed all doubt.)

To: Attention Surplus Disorder

No, it’s certainly not a secret for those of us that study the market. But it is what it is. The charts show it. As to whether that inverse relationship has started to break down, who knows? Time will tell. All these kind of relationships seem to eventually break down.

The same inverse relationship exists between the dollar and precious metals, so in effect, the decline in the dollar is driving up the cost of PM’s, though the run to PM’s as a safe haven has exacerbated that rise in the US\$ price of PM’s.

24 posted on 07/02/2011 8:12:28 PM PDT by Babu

To: blam

PING

25 posted on 07/03/2011 4:03:01 AM PDT by Armed Civilian ("Extremism in defense of liberty is no vice, moderation in pursuit of justice is no virtue.")

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