Stock Market Valuation: January 1st 2011


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 with the help of my colleague , I am adding the seventh metric- AAII-Investor Survey.
I collaborate with two colleagues of mine for some of the data in this article, Doug Short of and my friend who runs Both are great sites, and I encourage readers to check them out.

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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 January 1st, 2011:

The current P/E TTM is 16.6, which is slightly higher than the TTM P/E of 16.4 from last month.

s&p500 p/e ttm january 2011
click to enlarge

This data comes from my colleague Doug Short of

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 accounts . 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 []

Current P/E 10 Year Average 22.94

S&P 500 PE Ratio Chart
click to enlarge

The current ten year P/E is 22.94; this is higher than the PE of 22.34 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:

future returns of stock market based on shiller 10 year pe
click to enlarge

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 22.6.

s&p500 shiller pe ratio january 2011
click to enlarge

Mean: 16.38

Median: 15.76

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 []

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

Current P/BV 2.22

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 2.22; this is above P/B of 2.03 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 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 1.78

S&P 500 Dividend Yield Chart january 2011
click to enlarge

The current dividend yield of the S&P is 1.78. This number is lower than the 1.83% 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 []

Market Cap to GDP 91.1%

Ratio = Total Market Cap / GDP Valuation
Ratio < 50% Significantly Undervalued
50% < Ratio < 75% Modestly Undervalued
75% < Ratio < 90% Fair Valued
90% < Ratio < 115% Modestly Overvalued
Ratio > 115% Significantly Overvalued
Where are we today (01/01/2010)? 91.1 Modestly Overvalued

The current level of is 91.1%, is higher than the 88.6% number from last month.

Stock Market Capitalization as a percentage of GDP is another metric albeit less commonly used than other metrics, to value the market. Between 90-115% market capitalization as percentage of GDP is considered modestly overvalued  (we are at the low end of the range). Based on Guru Focus data the market should return about 4.5% per year based on the current value.

Warren Buffett has stated that market capitalization as a percentage of GNP is “probably the best single measure of where valuations stand at any given moment.”

According to Barron’s the ratio got as low as 40% in the late 1940s, when investors feared another depression, and in the inflationary 1970s.

Historic Data:

Min 35% in 1982

Max 148% in 2000.

Data and charts courtesy of

Current Tobin’s Q 1.15

tobins q historic chart january 2011
click to enlarge

Tobins Q is X compared to 1.05 from last month.

The data comes from Doug Short. This is the most accurate data that is available. It is impossible for the data to be 100% precise because the Federal Reserve releases data related to Tobin’s Q on a quarterly basis. The best that can be done is to extrapolate the data and try to provide the most accurate data possible based on the change in the Willshire 5000. This is what Doug and I did to get the current number. This method has proven extremely accurate for calculating Tobins Q on any given day.

The current level of 1.12 compares with the Tobins Q’s average over several decades of data of approximately .72. This would indicate that the market is extremely overvalued.

In the past Tobin’s Q has been a good indicator of future market movements. In 1920 the number was at a low of .30, the next nine years included phenomenal gains for the market. In 2000 Tobin’s Q almost reached a record high of nearly 2, and the market declined subsequently about 50% by 2003.

Historic Tobins Q:

Market Low 1932 0.30

Market High 1929 1.06(this is not the highest number ever reached, just the number reached before the 1929 crash).

Average historic Tobins Q .72 (source: Stocks for the Long Run by Jeremy Siegel

In my next monthly article I will have more Tobin’s Q historical data.

AAII Survey-51.60% Bullish, 28.3% Neutral, and 20.10% Bearish:

aaii investor sentiment chart
click to enlarge

With the collaboration of my colleague of I have now added a seventh metric for valuing the market. This data comes from the survey conducted by the American Association of Individual Investors (AAII) conducted on a weekly basis. According to the AAII “The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. Only one vote per member is accepted in each weekly voting period.”

As mentioned above, the survey results indicate investors are; 51.60% Bullish, 28.3% neutral, and 20.10% bearish. The fact that so many investors are bullish is a contrarian warning signal. Investors tend to get the most bullish at market tops, and bearish at market lows.

aaii survey and subsequent s&p500 returns
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aaii investor sentiment percentage bullish
click to enlarge

Below is AAII data from previous market bottoms (the AAII began the survey in 1987).
The charts essentially show that on average, returns have been more favorable when bullish sentiment is below 28% vs above 50%. The 1yr avg return when sentiment is above 50% is 1.9% vs 13.6% when sentiment is below 28%.

Bullish    Neutral  Bearish

Mar 2009              18.92%  10.81%  70.27%

Mar 2003              34.3%    14.30%  51.40%

Oct 1990               13.00%  20.00%  67.00%

Nov1987                31.0%    41.00%  28.00%

Average                 39.00%  31.00%  30.00%

Max                       75.00%  62.00%  70.00%

Min                         12.00%  8.00%   6.00%

Chart and data courtesy of

To Recap

1. P/E (TTM)- Fairly Valued

2. P/E (10 year average) Very Overvalued

3. P/BV- Undervalued

4. Dividend Yield- Indeterminate/ overvalued

5. Market value relative to GDP- Moderately Overvalued

6. Tobins Q- Very overvalued

7. AAII Sentiment- Too bullish (overvalued)

In conclusion the market is over-valued based on the above data. Tobins Q, Shiller PE and AAII data are all indicating that investors are too bullish and valuations are too high.

However the historical data fails to take into account current record low interest rates. I know not many investors take issue with my inclusion of interest rates in the equation. However, I think that most investors look at the stock/bond alternative. Right now you can get some blue chip stocks with dividend yields close to the Ten year treasury yield.

However, eventually the market will likely returns to normal valuation ratios as interest rates reach more normal levels. I believe returns over the next 10 years will be sub-par (below the 9.5% average market return). I think we will likely see returns equal to inflation over the coming decade.

You can read more about my predictions in the following two articles:

What Will The S&P 500 Return Over The Next 10 Years Part I

What Will The S&P 500 Return Over The Next 10 Years Part II

Note: I have received numerous suggestions on how to improve my monthly series. I tried to incorporate these ideas in my current article. Please email me or leave a comment if you would like to provide further suggestions.

Stay tuned till the beginning of next month for the next monthly valuation article.

Valuing Wall Street : Protecting Wealth in Turbulent Markets by Andrew Smithers. The book explains in detail how tobin’s Q is calculated.

Wall Street Revalued: Imperfect Markets and Inept Central Bankers. A more recent book by Andrew Smithers.

Irrational Exuberance By Robert Shiller. Great book by the man who calculates the P/E 10 ratio himself, Robert Shiller. The book is written in 2000, right before the tech bubble crash. Shiller correctly predicts the crash.

Disclosure: None

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