March 19, 2018

For today's bulletin, we take a look at our latest historical market valuation calculations.

VALUATION WATCH: Overvalued stocks now make up 56.07% of our stocks assigned a valuation and 21.35% of those equities are calculated to be overvalued by 20% or more. Thirteen sectors are calculated to be overvalued.

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ValuEngine: Market Valuation Remains Within Normal Range

ValuEngine tracks more than 5000 US equities, ADRs, and foreign stock which trade on US exchanges as well as @1000 Canadian equities.  When EPS estimates are available for a given equity, our model calculates a level of mispricing or valuation percentage for that equity based on earnings estimates and what the stock should be worth if the market were totally rational and efficient--an academic exercise to be sure, but one which allows for useful comparisons between equities, sectors, and industries. Using our Valuation Model, we can currently assign a VE valuation calculation to more than 2800 stocks in our US Universe.

We combine all of the equities with a valuation calculation to track market valuation figures and use them as a metric for making calls about the overall state of the market.  Two factors can lower these figures-- a market pullback, or a significant rise in EPS estimates. Vice-versa, a significant rally or reduction in EPS can raise the figure. Whenever we see overvaluation levels in excess of @ 65% for the overall universe and/or 27% for the overvalued by 20% or more categories, we issue a valuation warning. 

We now calculate that 56.07% of the stocks to which we can assign a valuation are overvalued and 21.35% of those stocks are overvalued by 20% or more. These numbers have increased slightly compared to what we saw when we published our last valuation study in August, 2017. At that time, we saw an overvaluation figure of 52.16%.

We finally fell below the critical 60% threshold for an overvaluation watch near the end of July 2017. Figures remained normal throughout August and most of September. Then, we re-issued a valuation watch from September 28th-October 31st. Once the market began to climb again after the election of Donald J. Trump, valuations grew briefly overheated and necessitated another Valuation Watch for a few days at the end of November and beginning of December-- and then once more at the end of December and throughout January and early February, 2018.

Since we called off our last Valuation Watch on February 5th, the market has seen some volatility return thanks to Trump's erratic policy pronouncements on issues such as trades and tariffs, the Russia investigation, tensions with North Korea, etc. However, valuation data has remained within "normal" range. It does tend to creep up whenever the market manages to recover and put in a bit of a leg up.

Currently, the numbers do not indicate that the market is overheated and things have stabilized as the the earnings picture has improved and share prices appear more reasonable to our models.

Of course, when it comes to US foreign policy, peace and negotiations are better for stocks than bluster and war.

Domestically, one cannot help but think that Trump occupies an ever-shrinking patch of ground, with Mueller appearing to be closing in on the "big fish" with every new subpoena and indictment. Would impeachment be plus or a minus for stocks? One can imagine the shock would cause damage, but perhaps we could see a "relief rally" as well as investors might value a return to steady direction and "normalcy" in DC.

As always, we caution readers to leave their political predilections out of their portfolios--and beware of pundits who make claims based on their own.

We do however, find that replacing a Gary Cohn with a Larry Kudlow as Trump's primary economic advisor will be a negative given Kudlow's long and well-documented record of being wrong about almost everything when it comes to the markets and policy--seriously, google it, the internet has already provided numerous accounts of some of Kudlow's more ridiculous calls and predictions.

Trump is running out of bodies up there, and it is becoming more-and-more difficult for the administration to find people who have not spoken out against him--and thus meet his own criteria for loyalty--who are also respected in their positions and competent for the higher roles AND who are willing to work in a White House in a constant state of crisis and chaos. One hopes that the US can avoid any true crises of both foreign and domestic nature as the White House become more isolated and increasingly unable to attract top-notch talent.

These concerns aside, overall we retain a positive outlook for stocks in the short term. But, longer term we believe that the massive Trump/GOP tax cuts combined with higher interest rates and government borrowing--have you checked the deficit figures lately?--will lead to trouble down the road just as the 80s Reagan "miracle" begat Bush the Elder's 90s recession.

We note too that while we have seen some wage growth lately, it is not enough to allow workers to finally regain all the lost ground of the past few decades. We fully expect the Fed to remove the so-called "punch bowl" well before workers can enjoy the wage increases necessary to restore balance to our system. If you throw a trade war into this mix, we become even less sanguine about the future.

We remind readers that "autarky," the system which existed prior to WWII where great nations raised trade barriers and sought their own isolated markets, self-sufficiency, and independence was NOT a stabilizing force and led to conflict and destruction.

Indeed, much of the post-war world order was created by the US precisely to bind nations together through open trade so that all could compete. This was also of great benefit to the US and its own economy. The Bannon wing of the GOP-- and Trump himself --seem to forget this history as they tear up international trade agreements and proclaim trade wars "easy."

They also damage US credibility when they make blatantly untrue statements about various trade balances and then try to lie about their factual inaccuracies in order to make them appear correct after the fact. Numbers don't lie!

In any case, below we present our valuation figures for the various timeframes we track in our historical studies. You can draw your own conclusions about recent history, recent administrations, and the markets from the data.

The chart below tracks the valuation metrics from March 2017. It shows levels in excess of 40%. Here you can see our recent-past Valuation Watches--when the red bars exceeded 60%.

   This chart shows overall universe over valuation in excess of 40% vs the S&P 500 from March 2015. Here we see that the last really long-term buying opportunity occurred back in early 2016. The undervalued condition has not really held sway since then.

This chart shows overall universe under and over valuation in excess of 40% vs the S&P 500 from March 2007.* Look at that growth since the markets bottomed out after Bush the Younger's financial collapse and Great Recession. We've come so far since that "devilish" 666 inter day SP500 low of March 9, 2008!

Notice too that the long-term chart put the so-called "Trump rally" in its proper context. We've been on a bull run most of the time since that low. You'd be hard pressed to figure out when the Obama administration gave way to Trump without the date labels on the X-axis.

 *NOTE: Time Scale Compressed Prior to 2011.

Finally, this chart shows the market from October 2016-present. We use this one to evaluate the so-called "Trump rally" for the markets. Again, a nice leg up, but that dip at the beginning of February sure raised some doubts for this particular vein of Trump triumphalism.