Back in 2001, Buffett said in an interview with Fortune Magazine that “the single best measure” of stock market valuation is by taking the total market cap (TMC) and dividing it by the total gross domestic product (GDP). Today, TMC is equal to 114.5% of total GDP.
At the market top in 2007, just prior to a -54% crash in stocks, TMC was equal to 104.9%. According to Buffett’s “favorite” market timing indicator, stocks are more overvalued today than in 2007.
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What’s more, since the market low in 2009 (when the ratio was at 56.8%–the first time in 15 years that stocks were truly “undervalued”), the ratio has climbed for six consecutive quarters and is now nearly two standard deviations above the mean.
However, just because a market is overvalued does not mean that a crash or even a significant correction is immediately imminent. Given the unprecedented negative 2.9% adjustment to US first quarter GDP figures, I expect this earnings season is going to be quite volatile. As usual, there will be good days and bad days but overall, barring any unexpected shock, I expect the current trend to be maintained.
That being said, Dow Theory is giving us some mixed signals.
The Transports are far stronger than the Industrials. There is no divergence as such but the flat-lining of the Dow 30 index is giving me cause for concern and I will be paying particular attention over the next 3 weeks for early signs of technical breakdown.
The bell-weather consumer staples ETF: XLP is also giving mixed signals. While the overall ETF is technically strong, T J Max, Proctor & Gamble, Wal-Mart, Costco and Visa are showing early signs of price deterioration.
Thus, all in all, I think the July earnings season will tell us a lot regarding whether the bull is going to last. I am beginning to have my doubts. Caution is warranted.
Charts Courtesy of SharpCharts.Com.
© Christopher M. Quigley 1st. July 2014.
wealthbuilder @ eircom.net