Q Ratio Indicates Stock Market Value Historically is Overpriced. We use many indicators to analyze stock market value and future trends. One such popular indicator is the Q Ratio. It was developed by Nobel Laureate James Tobin to estimate the fair market value of the stock market for the long term. The ratio is the total price of the market divided by the replacement cost of all its companies.
As you can see from the chart below, present fair valuation is quite high at 1.79. Therefore, this suggesting the market is trading at 129% above the mean historic replacement cost, says Jill Mislinski of Advisor Perspectives. Note that the all-time Q Ratio high at the peak of the Tech Bubble was 2.17, about 180% above the historic average of replacement cost. The all-time lows in 1921, 1932 and 1982 were around 0.28, which is approximately 63% below replacement cost. Mislinski cautions this is not a short-term indicator. “Periods of over- and under-valuation can last for many years at a time,” she says. That means the Q Ratio is “ more appropriate for formulating expectations for long-term market performance”.
Companies are Raising Their Earnings Outlook: Be Careful! Spurred by pandemic fears many companies earlier this year pulled way back on their profit outlooks. In fact, many said they couldn’t make any predictions at all. In recent weeks, however, with an increase in business openings and employment, these companies, and the analysts who follow them, have become increasingly optimistic about future earnings. As the chart below shows, a great percentage of companies are raising their earnings. In fact, by some definitions companies haven’t raised their outlooks to this degree in 20 years.
So ,why are we telling you to be careful? The most obvious reason is that record daily Covid-19 infections now are forcing even the reddest states to close many businesses that had been reopened. So, the economic outlook may not be as rosy as the companies thought, despite June’s big employment growth. Equally important is that historically by the time companies have become this enthusiastic about future earnings, investors and the market already have anticipated the gains. That means the stocks and the indexes are already fully priced in anticipation of the higher earnings, And fully priced means that bad news, including lower-than expected earnings, is a setup for a big market drop. So be careful and don’t become victim to irrational actions spurred by the fear of missing out (FEMO). FEMO historically results in investors buying too high and selling too low.
It’s No Surprise Stock Market Analysts Have Been Upgrading Price Forecasts At just the Wrong Time. In our view, many Wall street analysts are about as reliable at forecasting stock prices and market direction as fortune tellers who use smoke, mirrors, and crystal balls to summon your long-dead great aunt. In fact, they are wrong so often that they are a fairly reliable contrarian indicator on market direction (see chart and tables below). That’s why it is no surprise to us that Wall Street experienced another giant hiccup this week in the midst of analysts upgrading price forecasts. Why no surprise? The analysts were
upgrading despite warning signs based on historically-proven statistics we use that the market was climbing toward dangerously high price levels. To put this into perspective, we’ve been saying for weeks that the market was becoming very overbought based on very reliable indicators. That includes Warren Buffet’s favorite: Comparing total market capitalization to the GDP, which was at one of its most dangerous levels ever. We also talked about the S&P 500 relative stock industry being the most overbought In history.
It was this kind reliable, unemotional statistical analysis we were using to tell you the market had become oversold in March when stocks collapsed spurred by the corona virus panic . And what were the wizards of Wall Street doing amid clear signs of a bottom? They were panicking because they’d been caught off guard at the peak. Rather than being caught off guard again, they were following emotion. So, they were downgrading price forecasts at an historic rate when the statistics were saying otherwise. This all begs the question about whey are the analysts so wrong, so often. The obvious answer, of course, is they don’t follow the historically-proven statistics. Truth is these high-paid, so-called experts who should know better fall into the same emotional frenzies that make investor sentiment a highly reliable contrarian indicator. So, they also are subject to something we call FEMO, “the fear of missing out.” Another to the mistaken belief that to disregard history because “this time things are different”
Now, the wall Street gurus will defend themselves by saying they couldn’t have predicted the coronavirus, just as they were caught off guard in the past by other events. That’s subject to another debate. Reality is that the statistics we use, and they too often ignore, are important indications on the health of the market. In this way, you don’t have to know exactly what will cause the next downturn, or upsurge. However, what the statistics are telling you is that when stock prices are historically too high, for instance, you should be prepared for unforeseen events that could pull the rug out from under it. And this time is never different.
Analysts are chasing the trend… again
Published on June 23, 2020 by Troy Bombardia
Analysts were aggressively upgrading their price targets for S&P 500 stocks almost 2 weeks ago as the U.S. stock market (and tech stocks in particular) surged. Keep in mind that back in March, analysts were downgrading their price targets at the fastest clip ever as they bet on the end of the world.
The following contrarian signal looks at the net number of S&P 500 stocks for which Wall Street analysts have upgraded their price target (# of upgrades – # of downgrades).
“With a rise in social unrest, confusion over the pandemic response, and a highly volatile market, the probability of President Trump holding onto his office has dwindled,” says Jason Goepfert of SentimenTrader. Why? “Whatever one’s political association, there seems to be a clear correlation between re-election odds and the price path of the Dow Industrials,” says Goepfert. He notes, however, that with any correlation “it is hard to know whether it’s just happenstance, or even which one might be causing the other.”
Goeppert looked at the performance of the DJIA for the 100 days before a presidential election. That’s about the time until this year’s election. As the charts and tables below show, prior to a Republican winning, the Dow didn’t suffer a single loss. However, the DJIA showed losses for the six months when a sitting Republican lost to a Democrat. Except for 1932. So, if history repeats itself in 2020, the President and the Wall Street bulls should be praying for a steady increase in the DJIA until election day.
We use numerous indicators to guide us on the strength and weakness of the stock market in terms of when to buy, sold and hold. One of the important short-term indicators we follow is the 14-day S&P 500 Relative Strength index (RSI) which shows us the percentage of stocks that are overbought or oversold in the S&P 500. When the S&P 500 RSI is above 70% that tells us the stock market is overbought. Meanwhile, 30% and below tells us that the market is oversold. That generally indicates buying opportunities. The chart below shows us that the S&P 500 RSI is not only over 70 but is at its most overbought level ever. That is an indication to be very careful.Certainly for the short-term.