Posted with permission from Value Walk

Household Equity Ownership The Best Contrarian Indicator?

July 8, 2016
By Steve Blumenthal

Bonds are what they are. Today, they are less than what they are. It is said—nothing is ever new under the sun of finance… but we do live in a unique time in two critical ways—interest rates and monetary moment.

A few years ago, a book appeared called A History of Interest Rates… The book is a chronicle of 5,000 years of interest rates… Not a single line about negative yields. From Hamrabi to Ben S. Bernanke, negative yields were nonexistent.  Today, they are here in plethora.

Two-thirds of those are Japanese.  A trillion of French and a trillion of German.  Every single Swiss, now yields less than zero.  And yet, people seem to want them more for that.

A Fitch (the rating agency) press release characterized the demand for these assets as the demand for ‘safe’ assets.  For all the world, the bond market seems to have the notion that sovereign debt is intrinsically and indisputably safe.

I was born a few months after yield made their lows in April of 1946… Today, people seem to feel negative yielding securities are inherently safe because interest rates always go down.  Curiously enough, the bond bear market beginning in 1946…

The ECB has been buying sovereign debt including Italian debt hand over fist.  These distortions inform every single corner of our capital markets.

These prices are under the thumb of government… We live in a central banks constructed hall of mirrors.

From Jim Grant’s keynote address at NYSSA Conference.  Jim is the author of Grant’s Interest Rate Observer.

Jim goes on to recommend gold.  He said, “The case for gold is not that it’s a hedge against monetary disorder, but that it’s an investment in monetary disorder, the dynamic we’ve seen play out since 2008.  Radical monetary policy begets more radical monetary policy…”

We are living in an unprecedented interest rate and monetary policy period in time.  As for gold, it moved into a cyclical bull market environment in January and the trend remains bullish. (Please visit my Trade Signals post and scroll down to the gold chart).  I like gold for up to 10% of a total portfolio structure.

Today let’s take a look at what the most recent equity market valuation data is telling us.  We’ll look at one-to-three year, seven-year and 10-year forward time horizons.

You’ll find that U.S. equities are significantly overvalued.  This continues to suggest caution and setting realistic expectations on stock market returns.

Being the quant junkie that I am, I’ve found a couple of really cool charts I believe you’ll find interesting.  Do you follow Value Line?  One of the charts looks at Value Line’s price targets for individual equities.  Another looks at equity ownership as a percentage of total household net worth and it has an amazingly accurate record of telling us what the 10-year forward returns may likely be.

I hope you enjoy today’s piece.  Grab that coffee.  There are a lot of charts but the read is quick.

? If you are not signed up to receive my weekly  On My Radar e-newsletter, you can  subscribe here. ?

Included in this week’s On My Radar:

  • What Valuations Tell Us About Future Equity Market Returns
  • What’s Been Driving Stocks Higher? Aggregate Cash Spent on Acquisitions
  • Trade Signals – A Great First Half for Long Duration Bonds and High Yield
  • Concluding Thoughts and a Few Ideas

What Valuations Tell Us about Future Equity Market Returns

Let’s do a quick run-through of various valuation measures and then look at probable forward returns:

  1. Average of Four Popular Valuation Measures

Note in this chart ( source) that the average of four valuation indicators (Crestmont P/E, Shiller Cyclical P/E, Q Ratio and S&P Composite) is 76% above the mean as noted by the solid red line (the mean is the average of the four valuation measures dating back to 1900).  Markets tend to move above and below the mean (solid blue line).

Note too that the most overvalued level was at 157% above the mean at the market peak in early 2000.  It recently peaked at 87% and is currently at 76%.  There were only two prior periods when valuations were higher – 1929 and 2000.


Here is a summary of the four market valuation indicators we update on a monthly basis.

  • The Crestmont Research P/E Ratio ( more)
  • The Cyclical P/E ratio using the trailing 10-year earnings as the divisor ( more)
  • The Q Ratio, which is the total price of the market divided by its replacement cost ( more)
  • The relationship of the S&P Composite price to a regression trendline ( more)
  1. Median P/E (Ned Davis Research (NDR) calculation) – 22.9 as of June 30, 2016

Median P/E for the S&P 500 Index is the point in which 250 of the 500 stocks’ P/E ratios are higher and 250 of the stocks’ P/E ratios are lower.  I like it because it takes out a lot of one-time accounting gimmicks and sets a reasonable level to compare it versus the month-end median P/E going back in time.

The June 2016 reading of 22.9 puts us in quintile 5 (most expensive).  If we break each month-end median P/E going back to 1926 through December 2014 into five separate quintiles (1 being the lowest P/E and 5 the highest) and then look at what the actual subsequent 10-year annualized returns turned out to be, we can compare where we are today and get a sense of a probable future outcome.


To help you get a sense for what is historically inexpensive and what might be considered expensive, following a breakdown of the median P/E ranges 1981 through December 2015 (quintiles 1 through 5):


The 52.3 year Median P/E is 16.9.  I believe that identifies a point at which U.S. large-cap stocks are fairly priced.  My plan is to switch from 30% equity (hedged) exposure to 50% when we get to quintile 3.

Based on today’s earnings, median fair value in the S&P 500 Index is at approximately 1550.  The S&P 500 is near 2100 today.  This means the market will need to decline 26% to get to a point in which it is fairly valued.

U.S. stocks are significantly overvalued.  We should be cautious with our expectations regarding future returns.

  1. Price-to-Sales

The blue rectangle shows the level at which prices are high relative to sales.


The next chart show what the returns for the S&P Industrial Average looks like (data 1954 through March 2016) when the price of the market was high:


The conclusion here is to expect 3.66% gains per annum.

  1. Price-to-Operating Earnings

You’ll see in the middle section of the chart that prices are expensive relative to operating earnings.  The current reading is 20.82.  Based on that figure, take a look at the bottom right hand corner of the chart and see what