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Chart of the Day: Stock Market Bubble – Setup for a 50% Crash?

Stock Markets are on a parabolic run where it seems as if they will never ever go down. Are stocks in a bubble? Perhaps, but no one dares go short. Fund manager Michael Burry of “The Big Short” fame exited bearish bets on Tesla Inc, Alphabet Inc’s Google, and fund manager Cathie Wood’s ARK Innovation fund last quarter, according to SEC filings released.

In the semi-annual Financial Stability Report, the Fed issued a stock market warning as elevated valuations are causing markets to be “vulnerable to significant declines.” See the following Fed warning and learn more here.

Prices of risky assets generally increased since the previous report, and, in some markets, prices are high compared with expected cash flows. House prices have increased rapidly since May, continuing to outstrip increases in rent. Nevertheless, despite rising housing valuations, little evidence exists of deteriorating credit standards or highly leveraged investment activity in the housing market. Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall.

To answer this question of whether we are in a stock market bubble, check out the following four charts to get a historical perspective of where the current US stock markets are at in terms of several key indicators. Note how far these indicators are from the norm. At some point, markets always tend to return to the norm and often exceed this norm on the downside on an equal basis that they have exceeded on the upside.

This chart shows the trailing twelve-month S&P 500 PE ratio or price-to-earnings – see source data. The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.

SP500 PE Ratio Historical 2021This chart shows the inflation-adjusted market capitalization relative to the GDP. Often called the Buffet indicator – learn more here.

Real Makret Cap To GDP Ratio Historical 2021

This chart shows the price-to-sales relative to sales. The price-to-sales (P/S) ratio is a valuation ratio that compares a company’s stock price to its revenues. It is an indicator of the value that financial markets have placed on each dollar of a company’s sales or revenues.

SP500 Price To Sales Historical 2021

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The CAPE ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle. The CAPE ratio, using the acronym for cyclically adjusted price-to-earnings ratio, was popularized by Yale University professor Robert Shiller. It is also known as the Shiller P/E ratio.

SP500 Shiller Cape Ratio Real Index Historical 2021

These are just four indicators – there are more, even more, with an alternative view. A few observations when viewing these indicators.

  • To get back to even the norm, stocks need to fall 50% on an inflation-adjusted basis. On a non-inflation-adjusted basis, perhaps less. If inflation continues at a more aggressive rate, getting back to the norm may not need a dramatic fall in stock prices.
  • Stocks do not have to fall to get back to the norm. They could merely stall in price for a period of time for the business activity to catch up to the price anticipation already built-in to the stock prices. After a parabolic move in price, however, this seems unlikely.

Where the current stock market rampage ends, no one knows. “The four most dangerous words in investing are – this time it’s different.” – John Templeton.

See more #chartoftheday posts.

 RWR original article syndication source.

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