Why The S&P 500 Is Overvalued (And How To Become A Main Street Investor On Wall Street)

| About: SPDR S&P (SPY)

Summary

Examines why the S&P 500 Index is so overvalued based on Main Street data.

Explains why this is no longer your father's market.

Explains the dangers of current Central Bank policy.

Yesterday my friend and fellow Seeking Alpha contributor Mark Bern emailed me this link to a Seeking Alpha Chart of the Day by David Stockman, which I believe to be the most telling chart of why the S&P 500 Index (NYSEARCA:SPY) is so overvalued right now. Here's the chart again so everyone can view it as I discuss it further:

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This chart has a personal connection for me as I was born on March 23, 1964, and the chart begins on March 31, 1964, so basically it covers my entire lifetime and more importantly my 42 years as an investor. In 1974 toward the end of the OPEC oil embargo my great uncle and father took me by the hand and walked me over to an Exxon gas station that was near our family restaurant in Ossining NY, the Highland Restaurant (which our family ran for almost 40 years) and taught me my first lesson on how to be a Main Street investor on Wall Street.

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On the left side of the picture above was an Exxon station (NYSE:XOM) and the only reason I mention it is because (OPEC oil embargo) for many months in 1973-1974 there were long lines of people lining up in cars waiting to buy gas, which not only blocked the entire entrance to our restaurant, but dwarfed the current day lines that you may have seen at an Apple Store (NASDAQ:AAPL) whenever a new iPhone model comes out.

What my great Uncle Andy and father taught me on that day was to watch for what happens on Main Street and then go and try to identify companies that you can actually invest in on Wall Street that will benefit, but to also make sure to only buy the best ones. Well at the ripe old age of ten years old I followed that advice and bought my first shares of Exxon (NYSE:XOM) then and kept investing in the company through Exxon's DRIP plan with my wages that I earned from working in that restaurant.

In those days investors would buy stocks in great companies and hold them for decades, as I bought Exxon in 1974 and held it to 1998 and bought Coca-Cola (NYSE:KO) in 1984 and held it to 1998. The only reason I sold my shares in both was to load up on Nokia (NYSE:NOK) in 1998, where I made a lot of money during the dot com boom and bust and even though I lost half of the gains I had made, I luckily got out in time and still booked a 100% profit for the years 1998 to 2001.

Anyways in the first chart above you can see that the monster gains in the S&P 500 Index were made from 1975 to 2000 and since December 31, 1999, we have seen this happen for the long-term buy and hold investor in the S&P 500 Index, the NASDAQ (NASDAQ:QQQ) and the Dow Jones 30 Index (NYSEARCA:DIA).

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Versus this for the S&P 500 Index from 1974 to 2000.

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Well as you can see there is a big difference between the two periods and explains why being a long-term buy and hold investor over the last 16 years has not been a period of wine and roses. There are many reasons why this has happened, such as the changes in technology and commission pricing that has allowed High Frequency Traders and Day Traders to enter the arena simply because commissions have fallen so low and technology has advanced so much. If memory serves me right, I believe an order to buy 400 shares of Exxon back in 1974 would have cost you a couple of hundred bucks in commissions, while today through companies like Interactive Brokers that same trade will cost you about a dollar or two in commissions. This of course benefits us as investors by keeping costs so low, but at the same time to our detriment these same low commissions also give anyone with a laptop, a brokerage account and mouse the ability to trade often, even though they may not know the difference between a balance sheet and a cooking sheet.

Therefore trading volume naturally increased as many players, who would not have been doing day trading prior to 2000, have entered the picture. Unfortunately these traders have done so (in most cases) without doing much in the way of research (except for maybe a little technical analysis). These two types of traders have had a major effect on the markets, as one tends to operate out of emotion and either falls in love with a chart pattern or panics and runs, usually in a herd/lemming fashion. Then if that is not bad enough you have high frequency traders (which we will call HFTs for the purposes of this article) who operate with zero emotion and trade in and out of shares in milliseconds and only care about one thing when trading and that is the bid and ask spread, and that's it. HFTs don't care what each company traded does and just trade in and out of it. It would not be a big deal if HFTs only accounted for a small minority of the volume of trades, but unfortunately the rest of us account for a majority of the volume occurring every day in the markets. So it is of little surprise that the long-term buy and hold investor may at times find that when a company has a one-time disappointing event happen, such as missing Wall Street's estimates by a few pennies on its quarterly earnings report, that the shares of its stock get pummeled and go down -15-20% in a few minutes of the open. This same scenario also could happen as a result of a rumor in a vague Twitter headline as many traders today just sell first on the headline and then only find out the facts later. This is a big difference from when I began investing for on the day I was born, for example, the S&P 500 Index traded 4,940,000 shares and yesterday traded 3,562,060,000 shares, so obviously this is no longer your father's stock market.

Main Street companies are bought and sold usually based on revenue and profits and I remember my father selling the Highland Restaurant for about 1 times revenue and that was with a 40% profit margin. Today McDonald's (NYSE:MCD) by comparison trades at 4.23 times revenue and that is with a 19% profit margin. On the retail side a company like Amazon (NASDAQ:AMZN) trades at 3 times revenue with barely a 1% profit margin and that comes out to a trailing PE of about 300. Now obviously Amazon is growing like weeds as it basically sells everything at cost and its CEO Jeff Bezos has basically trained shareholders not to look at profits but only concentrate on revenues. God help those shareholders if the revenue growth of the company were to ever slow, because that is the only thing keeping the stock price where it is and it's a long way down from the clouds where investors in the company believe its future is.

The original chart at the top of this article is screaming from the rooftops that Wall Street is operating as if we were in a major economic expansion instead of the recession that Main Street is clearly telling us that we are in. I'm a Main Street analyst by trade and only go to Wall Street to invest when I can find something to buy that I feel is a bargain. I have designed an algorithm, which I have named Friedrich, which analyzes the entire balance sheet, cash flow and income statements of a company for ten years in a few seconds and has thus given me the ability to analyze over 6,000 companies financials and generate what I call the Main Street price for each company. Once I have that, I then go and get the stock price that Wall Street values each share price at and compare the two. When I find a bargain I buy and when I don't I sit in cash and just wait. I'm currently 75% in cash as there is basically nothing out there of value to buy right now according to my research. I can say this after looking at the total results of how all 6,000 companies analyzed are shaping up where "6" is the best and "Short" is the worst.

As you can clearly see Main Street is not doing well as my research has 42.1% (or about 2,500 stocks) as potential shorts. Since I have the ability to analyze a great majority of companies that trade on the stock markets, I 'm also able to analyze ETFs, indices and mutual funds using a methodology that I introduced here on Seeking Alpha in this article. In that article I introduced what I call my "Friedrich Standings" and here's the latest one:

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As you can see from the table above that the average of the nine results above came in at 31% out of 100%, therefore my Main Street research falls right in line with the results of the first chart on the price to sales ratio for the S&P 500 Index. The most important part of that chart is this table:

When the price to sales of the S&P 500 Index is above 1.53, then the percent gain per annum is just 0.36%, but what is it at 2.22, which was the result for April 30, 2016? Pretty scary stuff when you see that the dot.com boom and bust peak came in at 1.65 and the 2007 peak came in at 1.85. The corrections that soon followed those two peaks in the chart were between -45% and -59%, so the odds are that this next correction could be even worse. My research on Main Street and the price to sales chart up on top are generated from facts based on the real numbers (I use GAAP) and it has been my experience that it is not smart to try to do the opposite of what the facts tell us in the stock market or in life in general.

Going forward it is unfortunate that the world's Central Bankers keep putting band aids on the cracks in the dam instead of letting the markets correct and valuations go back to rational levels. But instead of doing so these Central Bankers are unfortunately going in the opposite direction and are moving toward negative interest rates. In order not to end up writing you a book here, I would just have those of you who are interested read the following articles on the dangers of negative interest rates and what low interest rates are doing with regard to employment.

The World And The US Are Going Negative Interest Rates: What Should You Do To Prepare For It?

Fund managers fear central banks will create next 'Lehman' moment

'Frightening' number of unemployed have stopped looking for work

DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from our research. Factual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.

Disclosure: I am/we are long AAPL.

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.