Trump bump for stocks could end with market in the dumps By Mark Hulbert
* November 22, 2016
Post-election rally pushes U.S. stocks to even more unrealistic valuations
The U.S. stock market has become even more overvalued in the two weeks since Donald Trump’s election as the next U.S. president.
And that’s saying something, since it was already hugely expensive.
The accompanying chart tells the sobering story: Depending on which of six widely used valuation measures, the market currently is more overvalued than it was, at between 79% and 95% of the three dozen bull-market tops since 1900. (According to a bull-market calendar maintained by Ned Davis Research for a precise list of those market tops.)
Here’s a summary of these six measures featured in this chart:
· The price/book ratio, which stands at 2.7 to 1. The book value data I obtained extends only back to the 1920s rather than to the beginning of the 20th century, but at 23 of the 29 major market tops since then, the price/book ratio was lower than it is today.
· The price/sales ratio, which stands at an estimated 1.9 to 1. I only have per-share sales data back to the mid-1950s, but at 18 of the 19 market tops since then the price/sales ratio was lower than today’s. · The dividend yield, which currently is 2.1% for the S&P 500 SPX, +0.16% . At 31 of the 36 bull-market peaks since 1900, the dividend yield was higher.
· The cyclically adjusted price/earnings ratio, which currently stands at 26.6. This is the ratio championed by Yale University’s Robert Shiller. It was lower than where it is today at 30 of the 36 bull-market highs since 1900.
· The so-called “q” ratio. Based on research conducted by the late James Tobin, the 1981 Nobel laureate in economics, the ratio is calculated by dividing market value by the replacement cost of assets. According to data compiled by Stephen Wright, an economics professor at the University of London, and Andrew Smithers, founder of the U.K.-based economics-consulting firm Smithers & Co., the market currently is more overvalued than it was at 30 of the 36 bull-market tops since 1900.
· P/E ratio. This is the valuation indicator that is perhaps most-often quoted in the financial media. Nevertheless, according to data on as-reported earnings compiled by Yale’s Shiller, and based on S&P estimates for the third quarter, this ratio currently stands at 24.4 to 1. That’s higher than at 89% of past bull-market peaks.
Trump could very well celebrate these lofty valuations as a big vote of confidence — big, really big — from the investment community.
But there’s a dark cloud inside that silver lining, namely that it will be harder for the stock market during Trump’s presidency to produce better than mediocre returns.
A potential rejoinder would be that today’s extremely low interest-rate environment justifies the stock market’s higher-than-average valuations. But this argument is questionable, for at least two reasons.
First, I’m unaware of any research that shows these valuation measures’ track records can be improved upon by taking interest rates into account. And other studies find just the opposite.
Consider a now-classic study by Cliff Asness that appeared in the Fall 2003 issue of the Journal of Portfolio Management. Asness measured whether the predictive success of the P/E ratio is in any way improved by adjusting it according to prevailing interest rates. He found that its track record actually became worse, not better.
There’s an even more basic reason for resisting the temptation to use low interest rates to rationalize today’s high valuations: Interest rates have spiked over the last two weeks. If we were to take the bulls’ rationalizations at face value, then the stock market should be lower today than it was on Election Day. And if you think interest rates during Trump’s presidency will average higher than they are today, logical consistency would compel you to project a lower stock market.
To be sure, the stock market has been overvalued for several years now, and so far a bear market has been averted. But that doesn’t mean it can be postponed forever.
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