For the past nine years, the equities market has seen one of the best
percent gains since the Bull Market of 1948-1969. Corporate taxes are
low, GDP growth is strong, and joblessness well below the Natural Rate
of Unemployment (NRU).
However, quite a few ratios, economic data, and past performances
are pointing to the conclusion that this bull market is close to its
conclusion. For all data, I will be using the S&P 500 Index. Sorry Dow Jones and Nasdaq.
Nobody loves you (well I love Nasdaq fuck Dow).
Not to be confused with the Buffet Rule, the Buffet Indicator
compares the Total Market Capitalization (Market Cap) of the stock
market divided by the Total GDP.
|Ratio = Total Market Cap / GDP||Valuation|
|Ratio < 50%||Significantly Undervalued|
|50% < Ratio < 75%||Modestly Undervalued|
|75% < Ratio < 90%||Fair Valued|
|90% < Ratio < 115%||Modestly Overvalued|
|Ratio > 115%||Significantly Overvalued|
As of 8/1/18, the Total Market Cap is 142.8% more than the total
GDP. This indicates a significantly overvalued market. In 2000, one of
the most notorious bubbles, the total market capped topped out at
148.5% of GDP. The 2009 lead up, had a top valuation of 110.7%.
For the past 20 years, the market has reacted to an overvalued
market by returning to a “Fairly Valued” TMC to GDP ratio. After the
tech bubble burst, the market went from a high of 148.5% to a low of
75.2%, a decrease of almost half. With the current market approaching
former tech bubble numbers, a bear market does not seem far off.
Buffet Indicator Graphs
The past 50 years of the Buffet Indicator. Notice 2000 and 2008.
29.3 Trillion in Total Market Cap vs. 20.4 Trillion in GDP.
Shiller P/E Ratio
The Shiller P/E Ratio is a better measure of valuation than normal
P/E. It accounts for the fluctuations of inflation due to the business
cycle, therefore providing a more accurate picture of the true value of
the security. Thankfully, there is a plethora of data surrounding the
Shiller P/E ratio, all the way back to 1890.
Shiller P/E Ratio over the past 120~ Years.
The grey bars mark U.S Recessions. Note 1929, 2001, and 2008.
MEAN: 16.9 (We are currently 53% above the mean,
indicating an overvalued market.)
MIN: 4.78 (DEC 1920)
MAX: 44.19 (Dec 1999)
Price To Sales (Revenue) Ratio
The Price to Sales Ratio (PSR), like the P/E ratio, is a way of
measuring value. Instead of comparing a company’s price to earnings, it
compares a company’s stock price to its revenues.
|Price/Revenue Per Share||PSR Valuation|
|PSR= 1-2||Fairly Valued|
|PSR= 3+||Significantly Overvalued|
The current for the S&P500 is 2.23, and at the height of the tech
bubble, 2.44, indicating overvaluation. The chart below shows that until
the late 90s, P/S never topped 1.3.
S&P500 Price to Sales 1955-2006
S&P 500 by Deciles 1986-Present
The graph above shows the S&P grouped into deciles (each of ten
equal groups into which a population can be divided according to the
distribution of values of a particular variable (in this case Price to Sales
Ratio)). Decile 10 shows that extreme speculation, especially in 2000, is
centered on a fraction of stocks; in case of 2000 those stocks were tech.
Currently, with the exception of Decile 10, the S&P is the most
overvalued it has ever been.
Now we move away from the fun world of ratios and into the
world of monetary policy. The Yield Curve is the curve of maturity and
interest rates. It is a crucial market sentiment indicator about the future
of the economy.
The normal yield curve shows that the shorter the maturity, the lower the yield.
The flat yield curve indicates a transition from an expansion to a downturn. Shorter maturities have the same yields as the
The Inverted Yield Curve is a strong indicator of coming recession. Shorter maturities have higher yields than longer maturities.
We are currently in a flat yield curve.
Bull exhaustion, a rapid rise in stock followed by a tail off called
an exhaustion gap. Bull exhaustion is common during the peak of the
bull market, and is a indication of a slowdown. This can be clearly seen
in the correction in early February.
The failure of the market to recover to its previous high (it has been 6 months, and the S&P hasn’t recovered fully yet),
combined with the low volume over the past few months, shows clear symptoms of Bull exhaustion.
Dow Theory (the Public)
Dow Theory is an one hundred year old theory about the stock
market written by Charles H. Dow (the Dow in Dow Jones). While some
of it isn’t relevant anymore (the reliance of railroads indicating trends) a
lot of it still is relevant.
The “Market Trends” part of Dow Theory is still particular
relevant, especially in the realm of behavioral economics. Dow Theory
states that there are three trends to the bull/bear cycle.
- Accumulation Phase
a. In the beginning of the bull market “In the know”
investors with a long-term outlook, and buy and hold.
- Public Participation Phase
a. The Public and amateur investors join into the market.
The uptrend becomes more obvious.
- Distribution Phase
a. The final stage of the bull market. The “in the know”
investors cash out, amateurs continue to join. Rampant
speculation ensues. The market enters a downtrend.
One of the trends I can definitely see today is the speculating
public. Amateur “investors” through apps like Robinhood can now
easily speculate with options and margin.
I believe we are in either late Public Participation Phase, or very
early Distribution phase. Here is a helpful graph to visualize this
Anyway. Draw your own conclusions. This is my first DD. Feedback and criticism is welcome.