How Cheap Can Equities Get? How Cheap Are They Now?

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Includes: DIA, IWM, QQQ, SPY
by: Peter F. Way, CFA

Summary

Equity market-makers [MMs] every market day bet on the first title question. Their bets reveal an answer to the second question.

We daily measure what their bets imply in coming price range prospects for ~2500 stocks and ETFs.

History of their prior expectations, and their continuing well-paid employment, is testimony to their insights.

The current Profile of stock value expectations

Figure 1 displays the proportions of upside-to-downside price change prospects implied in the hedging actions of the arguably best-informed investment professionals. The metric involved is the Range Index [RI], which tells for each equity issue what percentage of its expected range of coming prices lies below its current market price. The horizontal scale at the bottom is of Range Indexes.

Figure 1

(used with permission)

At this date more than half of this actively-traded, widely-held population of stocks and ETFs have upsides four times as large as their downsides (an RI of 20), and a sizable number of them are currently priced below their reasonable low extremes (an RI of zero or negative). Over 75 are beyond reason, off the scale, at left.

Maybe 1% of this population present more downside potential than upside (a RI of 50 or more.)

For the market to get much lower, still more stocks have to get into the proportions of 5-to-1 or more upside, than are seen there now.

By the way, the average upside expectation is already ~+18%. With similar prior expectations the worst-case average subsequent price drawdowns were -9%.

In 3 months more than half of them had prices ahead of where they were at those earlier forecasts, and had earned at a CAGR of +18%.

Conclusion

Equities could get as much as -9% cheaper, yet not likely all at once. But they're darned cheap now, offering substantial recovery prospects. Should equities be bought here? Sure, selectively, not by market averages. Hoarding cash here is a high-risk (to opportunity) strategy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.