Thoughts on Valuations, Stocks, and the Dollar

http://slopeofhope.com/2009/10/fair-value-of-sp-500.html

http://www.tradersnarrative.com/is-the-stock-market-cheap-after-a-50-rise-3168.html

http://www.tradersnarrative.com/technical-arguments-for-continued-weakness-3151.html


I have never talked a lot about valuation type measures of the markets on the blog. They are not really of value to the shorter term aspect of the trading on the blog. And I am in no way an expert in the area, but I do look at lots of charts and have tried to take in some different perspectives. The links above are a few that I thought I would pass along that regard longer term valuations of stocks relative to earnings.

From my perspective, the main economic issue at hand in our country and around the globe is the issue of debt/credit that has expanded with no accompanying productive output. As simple examples.....there is a difference between debt loaned to me to start a business where I build stuff and employ people and sell the stuff vs. debt loaned to me to buy a house that's already built that then I can't pay back and do nothing remotely productive with the debt. Also another thing to consider is just like any business or household in that there comes a point if you have too much debt that your interest you have to pay on those loans are so high that you can't meet your necessary obligations and then either go bankrupt or have to scale back in major ways.

Our country (government and populace) is awash in that second type of debt from the real estate hangover and financial derivative implosions, coupled with unemployment and corresponding declines in government revenues via taxes. And unfortunately there has not really been any type of accountability in the recognition and removal of that debt as perceived value from the creditors. Banks are now often not evicting and foreclosing against borrowers who haven't paid mortgages in months so that they don't have to account for the diminished value that the property is now worth compared to the original loan value, which obviously is not going to be repaid. So really when you see such extreme behaviors among lenders, there is something still vastly wrong and they all know it.

Because of these types of things going on across the board, my perspective aligns more with the first link above which factors in valuations relative to money supply growth being positive or negative. Because these basically fraudulent practices are still occurring without any enforcement, I think it is unwise to assume the the decline in money supply is done. So based on that article I think that it is reasonable to conclude that stocks are very overvalued in relation to a fundamental backdrop of debt deflation that has not run its course.

The other articles will give some differing perspectives and certainly everyone should try to make sense of it for themselves if considering what to do for a longer term investment horizon.

Now one thing that I doubt most people think a lot about is the value of stocks in relation to the value of the currency in which it is denominated. So it may be great to have a Dow of 100,000 or something, but that would not really mean you are wealthy if the value of our currency dropped to a tenth of what it is now. So what matters for wealth is purchasing power, not number value.

So building on that idea there are a couple ways that I have found helpful to look at valuation rather than just P/E ratios or that type of thing. One way is to look at the ratio of the value of stocks relative to commodities. So dividing the S&P 500 value by the CRB commodity index and looking at that over a long time frame will help to define periods where stocks are overvalued or undervalued relative to consumable "things".

Another way is to look at the value of stocks relative to the value of the dollar. So dividing the S&P by the US Dollar Index will help to recognize periods where stocks are trading at historically high or low levels compared to the dollar's value against other currencies. Currently, stocks are trading relative to the dollar at levels equal with the value in 2000. Stocks got even more expensive relative to the dollar in 2007 and early 2008, but then came way down last year. We aren't back to those highs now, but we're still at levels or beyond which the last 2 bear markets began.

So take what you will from all that, but I think that we are looking at a market that is at worst quite overvalued relative to historical P/E values and money supply change, and at best around fair value. Also, it seems that stocks are overvalued in US dollar terms which would take either a dollar advance, a stock market decline, or both to resolve in some measure.