Three Market Valuation Indicators Continue to Signal Caution
by Chart School - March 11th, 2011 12:35 am
Courtesy of Doug Short
Note from dshort: The Q Ratio in the charts below now incorporates the new Federal Reserve Flow of Funds Z.1 data released earlier today.
Here are the most recent monthly updates of the three valuation indicators I routinely follow:
- The relationship of the S&P Composite to a regression trendline (more)
- The cyclical P/E ratio using the trailing 10-year earnings as the divisor (more)
- The Q Ratio — the total price of the market divided by its replacement cost (more)
This post is essentially an overview and summary by way of chart overlays of the three. To facilitate comparisons, I’ve adjusted the Q Ratio and P/E10 to their arithmetic mean, which I represent as zero. Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which I’m using as a surrogate for fair value. Based on the latest S&P 500 monthly data, the index is overvalued by 64%, 48% or 43%, depending on which of the three metrics you choose.
I’ve plotted the S&P regression data as an area chart type rather than a line to make the comparisons a bit easier to read. It also reinforces the difference between the two line charts — both being simple ratios — and the regression series, which measures the distance from an exponential regression on a log chart.
The chart below differs from the one above in that the two valuation ratios (P/E and Q) are adjusted to their geometric mean rather than their arithmetic mean (which is what most people think of as the “average”). The geometric mean weights the central tendency of a series of numbers, thus calling attention to outliers. In my view, the first chart does a satisfactory job of illustrating these three approaches to market valuation, but I’ve included the geometric variant as an interesting alternative view for P/E and Q.
As I’ve frequently pointed out, these indicators aren’t useful as short-term signals of market direction. Periods of over- and under-valuation can last for years. But they can play a role in framing longer-term expectations of investment returns. At present they suggest a cautious outlook and guarded expections.
Note: For readers unfamiliar with the S&P Composite index, see this article for some background information.
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Treasury Yields Update
by Chart School - March 11th, 2011 12:35 am
Courtesy of Doug Short
The behavior of Treasuries is an area of special interest in light of the Fed’s second round of quantitative easing, which was formally announced on November 3rd. The first chart shows the percent change for a basket of eight Treasuries since November 4th. Yields have risen dramatically since then, although we’ve seen some reversal over the past three weeks punctuated with volatility over the past few days. The turmoil in North Africa and the Middle East together with the rise in gas prices have been key drivers of late.
The next chart shows the daily performance of several Treasuries and the Fed Funds Rate (FFR) since 2007. The source for the yields is the Daily Treasury Yield Curve Rates from the US Department of the Treasury and the New York Fed’s website for the FFR.
Here’s a closer look at the past year with the 30-year fixed mortgage added to the mix (excluding points).
Here’s a comparison of the yield curve at the time of the Fed’s QE2 announcement and the latest curve.
The yield spread had been widening in November and much of December, then contracted, and now show renewed signs of widening. The next chart shows the 2- and 10-year yields with the 2-10 spread highlighted in the background.
The final chart is an overlay of the CBOE Interest Rate 10-Year Treasury Note (TNX) and the S&P 500.
For a long-term view of weekly Treasury yields, also focusing on the 10-year, see my Treasury Yields in Perspective.
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Three Market Valuation Indicators Continue to Signal Caution
by Chart School - March 10th, 2011 7:35 pm
Courtesy of Doug Short
Note from dshort: The Q Ratio in the charts below now incorporates the new Federal Reserve Flow of Funds Z.1 data released earlier today.
Here are the most recent monthly updates of the three valuation indicators I routinely follow:
- The relationship of the S&P Composite to a regression trendline (more)
- The cyclical P/E ratio using the trailing 10-year earnings as the divisor (more)
- The Q Ratio — the total price of the market divided by its replacement cost (more)
This post is essentially an overview and summary by way of chart overlays of the three. To facilitate comparisons, I’ve adjusted the Q Ratio and P/E10 to their arithmetic mean, which I represent as zero. Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which I’m using as a surrogate for fair value. Based on the latest S&P 500 monthly data, the index is overvalued by 64%, 48% or 43%, depending on which of the three metrics you choose.
I’ve plotted the S&P regression data as an area chart type rather than a line to make the comparisons a bit easier to read. It also reinforces the difference between the two line charts — both being simple ratios — and the regression series, which measures the distance from an exponential regression on a log chart.
The chart below differs from the one above in that the two valuation ratios (P/E and Q) are adjusted to their geometric mean rather than their arithmetic mean (which is what most people think of as the “average”). The geometric mean weights the central tendency of a series of numbers, thus calling attention to outliers. In my view, the first chart does a satisfactory job of illustrating these three approaches to market valuation, but I’ve included the geometric variant as an interesting alternative view for P/E and Q.
As I’ve frequently pointed out, these indicators aren’t useful as short-term signals of market direction. Periods of over- and under-valuation can last for years. But they can play a role in framing longer-term expectations of investment returns. At present they suggest a cautious outlook and guarded expections.
Note: For readers unfamiliar with the S&P Composite index, see this article for some background information.
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The Q Ratio: Updated with Latest Federal Reserve Data
by Chart School - March 10th, 2011 4:35 pm
Courtesy of Doug Short
Note from dshort: This update incorporates the new Federal Reserve Flow of Funds Z.1 data released earlier today.
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 extrapolated the ratio since the latest Fed data (through 2010 Q4) 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.”
The average (arithmetic mean) Q ratio is about 0.71. In the chart below I’ve adjusted the Q Ratio to an arithmetic mean of 1 (i.e., divided the ratio data points by the average). This gives a more intuitive sense to the numbers. For example, the all-time Q Ratio high at the peak of the Tech Bubble was 1.82 — which suggests that the market price was 158% above the historic average of replacement cost. The all-time lows in 1921, 1932 and 1982 were around 0.30, which is about 57% below replacement cost. That’s quite…
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S&P 500 Closes Below Its 50-Day Moving Average
by Chart School - March 10th, 2011 4:35 pm
Courtesy of Doug Short
The S&P 500 closed the day down 1.89%, which puts it below its 50-day moving average for the first time since October 1, 2010. The index is 91.4% above the March 9 2009 closing low, which puts it 17.3% below the nominal all-time high of October 2007.
For a better sense of how these declines figure into a larger historical context, here’s a long-term view of secular bull and bear markets in the S&P Composite since 1871.
For a bit of international flavor, here’s a chart series that includes an overlay of the S&P 500, the Dow Crash of 1929 and Great Depression, and the so-called L-shaped “recovery” of the Nikkei 225. I update these weekly.
These charts are not intended as a forecast but rather as a way to study the current market in relation to historic market cycles.
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Charts Of Indexes Forecasted Sell-Off
by Chart School - March 10th, 2011 4:17 pm
BCSI
Classic first thrust down, puts in a bear channel, snapback rally call it what you will in pink, breaks it and it’s bombs away. One catch, the bombs away was earnings related. BUT that’s the pattern we want to see on the short side with names.
SLAB
You can see a break of the Pink Snapback rally (bear channel) that we’ve been highlighting. So could we keep going down here? Yes, as we got the break.
We’ve laid out a dark blue line in the daily charts here as they are prior support levels to be aware of. Should we get there in a hurry? It’s where our paying subscribers will lock in their short-sell gains!
To learn more, sign up for our free newsletter and receive our free report — “How To Outperform 90% Of Wall Street With Just $500 A Week.”
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Charts Of Indexes Forecasted Sell-Off
by Chart School - March 10th, 2011 3:35 pm
Courtesy of David Grandey
“First Thrust Down, Snapback Rally, Bombs Away”
BCSI
Classic first thrust down, puts in a bear channel, snapback rally call it what you will in pink, breaks it and it’s bombs away. One catch, the bombs away was earnings related. BUT that’s the pattern we want to see on the short side with names.
SLAB
You can see a break of the Pink Snapback rally (bear channel) that we’ve been highlighting. So could we keep going down here? Yes, as we got the break.
We’ve laid out a dark blue line in the daily charts here as they are prior support levels to be aware of. Should we get there in a hurry? It’s where our paying subscribers will lock in their short-sell gains!
To learn more, sign up for our free newsletter and receive our free report — “How To Outperform 90% Of Wall Street With Just $500 A Week.”
To learn more, sign up for David’s free newsletter and receive the free report from All About Trends – “How To Outperform 90% Of Wall Street With Just $500 A Week.” Tell David PSW sent you. – Ilene
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Time for a MAJOR “Trend Change?”
by Chart School - March 10th, 2011 1:31 pm
Courtesy of Chris Kimble
CLICK ON CHART TO ENLARGE
Commodity Research Bureau Index (CRB) of late hit its 61% fibonacci retracement level at (1) and at the same time FCX was creating a bearish rising wedge at resistance point (3).
Major Trend Change at hand? Too early to tell, yet from a pattern perspective it was a great place to enter positions to score on defense in SMN & DUG! This situation could be just as important and haver the same outcomes as the summer of 2008 for the CRB….
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Euro/Dollar Spread: Bad News for Stocks and Commodities?
by Chart School - March 10th, 2011 10:35 am
Courtesy of Doug Short
Technical analyst Chris Kimble updates his analysis of the Euro/Dollar spread with an observation of the possible impact on a couple of key asset classes.
Chris comments: The power of the pattern is suggesting a Dollar rally and a Euro decline.
In the past this has often foreshadowed lower stock and commodity prices.
If the pattern is correct, look how vulnerable commodities are in the CRB/FCX chart!
For the most up-to-date Kimble analysis, check out Chris’s blog: Kimble Charting Solutions.
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Why commodities and stocks could head lower from here…
by Chart School - March 10th, 2011 9:38 am
Courtesy of Chris Kimble
CLICK ON CHART TO ENLARGE
The “Power of the Pattern” in the above chart is suggesting that the Dollar was poised for a rally and the Euro a decline.
This is one of my tools I used to help us take positions to score on defense as we are owners of SMN, PSQ and DUG.
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
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coordinator for PSW. She manages the Favorites backup site
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