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I update market valuations on a monthly basis. The point of this article is to measure the stock market based on seven different metrics. This article does not look at the macro picture and try to predict where the economy is headed. It only uses these several metrics which have been very good past indicators of whether the market is fairly valued.

This month I added in GMO’s chart at the bottom. The GMO chart shows what the firm expects different asset classes to return over the next seven years.

I collaborate with two colleagues of mine for some of the data in this article, Doug Short of dshort.com and my friend who runshttp://seekingdelta.wordpress.com. Both are great sites, and I encourage readers to check them out.

As always, I must mention that just because the market is over or undervalued does not mean that future returns will be high or low. From the mid to late 1990s the market was extremely overvalued and equities kept increasing year after year. However, as I note at the end of the article I expect low returns over the next ten years based on current valuations. In addition, individual stocks can be found that will outperform or underperform the market regardless of current valuations.

To see my previous market valuation article from last month click here.

Below are six different market valuation metrics as of February 2nd, 2011:

The current P/E TTM is 16.8, which is slightly higher than the TTM P/E of 16.6 from last month (This specific data is from the market close February 1st).

s&p500 ttm market valuations
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This data comes from my colleague Doug Short of dshort.com.

Based on this data the market is fairly valued. However I do not think this is a fair way of valuing the market since it does not account for cyclical peaks or downturns. To get an accurate picture of whether the market is fair valued based on P/E ratio it is more accurate to take several years of earnings.

Numbers from Previous Market lows:

Mar 2009 110.37

Mar 2003 27.92

Oct 1990 14.21

Nov 1987 14.45

Aug 1982 7.97

Oct 1974 7.68

Oct 1966 13.96

Oct 1957 12.67

Jun 1949 5.82

Apr 1942 7.69

Mar 1938 10.63

Feb 1933 14.92

July 1932 10.16

Aug 1921 14.02

Dec 1917 5.31

Oct 1914 14.27

Nov 1907 9.35

Nov 1903 11.67

Historic data courtesy of [multpl.com]

Current P/E 10 (Shiller) Year Average 23.94

S&P 500 PE Ratio Chart robert shiller

The current ten year P/E is 23.94; this is much higher than the PE of 22.94 from the previous month. This number is based on Robert Shiller’s data evaluating the average inflation-adjusted earnings from the previous 10 years. Robert Shiller stated in an interview last week that he believes the S&P500 will be at 1430 in 2020. Shiller believes that based on his metric the market is overvalued, and will offer subpar returns over the next 10 years.

Based on my colleague, Rob Bennett’s market return calculator, the returns of the market should be as follows:

returns based on shiller 10 year pe
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My colleague Doug Short thinks this numbers are a bit inaccurate, because the number I used does not include the past several months of earnings, nor revisions. Doug calculates P/E 10 at 23.3

s&p500 10 year pe ratio market valuations
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Mean: 16.39

Median: 15.77

Min: 4.78 (Dec 1920)

Max: 44.20 (Dec 1999)

Numbers from Previous Market lows:

Mar 2009 13.32

Mar 2003 21.32

Oct 1990 14.82

Nov1987 13.59

Aug 1982 6.64

Oct 1974 8.29

Oct 1966 18.83

Oct 1957 14.15

June 1949 9.07

April 1942 8.54

Mar 1938 12.38

Feb 1933 7.83

July 1932 5.84

Aug 1921 5.16

Dec 1917 6.41

Oct 1914 10.61

Nov 1907 10.59

Nov 1903 16.04

Data and chart courtesy of [multpl.com]

This is moderately over valued from the average P/E as shown above.

Current P/BV 2.30

s&p500 price over book ratio january 2011
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The number is obtained using data from the spy ETF, and updated using the latest change in the price of spy. This number will therefore not be 100% accurate since the book value has likely changed (slightly) since the numbers were last updated on November 30th 2010.

The current P/BV is 2.30; this is lower P/B of 2.20 I measured in my previous article.

The average Price over book value of the S&P over the past 30 years has been 2.41. This indicates the market is slighlty undervalued. Book value is considered a better measure of valuation than earnings by many investors including legendary investor Martin Whitman. He states that book value is harder to fudge than earnings. In addition book value is less affected by economic cycles than one year earnings are. P/BV therefore provides a longer term accurate picture of a company’s value, than a TTM P/E.

Current Dividend Yield 1.74

S&P 500 Dividend Yield Chart february 2011
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The current dividend yield of the S&P is 1.74. This number is lower than the 1.78% yield from last month.

It is hard to determine on this basis whether the market is overpriced. The dividend yield for stocks was much higher in the begging of this century than the later half. The dividend yield on the S&P fell below the yield on Ten-Year treasuries for the first time in 1958. Many analysts at the time argued that the market was overpriced and the dividend yield should be higher than bond yields to compensate for stock market risk. For the next 50 years the dividend yield remained below the treasury yield and the market rallied significantly. In addition the dividend yield has been below 3% since the early 1990s. While I personally favor individual stocks with high dividend yields, I must admit that the current tax code makes it far favorable for companies to retain earnings than to pay out dividends. Finally, as I noted above the current economic environment has zero percent interest rates and low bond yields. During periods where yields are low it is logical for income oriented investors hungry for yield to be bid up the market, and dividend yields to decrease. I think it is hard to claim the market is overbought based on the low dividend yield.

Mean: 4.35%

Median: 4.29%

Min: 1.11% (Aug 2000)

Max: 13.84% (Jun 1932)

Numbers from Previous Market lows:

Mar 2009 3.60

Mar 2003 1.92

Oct 1990 3.88

Nov1987 3.58

Aug 1982 6.24

Oct 1974 5.17

Oct 1966 3.73

Oct 1957 4.29

Jun 1949 7.30

Apr 1942 8.67

Mar 1938 7.57

Feb 1933 7.84

July 1932 12.57

Aug 1921 7.44

Dec 1917 10.15

Oct 1914 5.60

Nov 1907 7.04

Nov 1903 5.57

Data and chart courtesy of [multpl.com]

Market Cap to GDP is currently 92.8%, which is higher than the 91.1% from last month.

Ratio = Total Market Cap / GDPValuation
Ratio < 50%Significantly Undervalued
50% < Ratio < 75%Modestly Undervalued
75% < Ratio < 90%Fair Valued
90% < Ratio

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