Market Valuation Indicators Signaling Caution

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Includes: DIA, QQQ, SPY
by: Prieur du Plessis

When considering valuation levels of the S&P 500 Index, it is always worthwhile stopping by Doug Short’s site for an update on three valuation indicators he routinely follows:

  • The relationship of the S&P Composite to a regression trendline (more)

  • The cyclical P/E ratio using the trailing 10-year earnings as the divisor (more)

  • The Q Ratio – the total price of the market divided by its replacement cost (more)

To facilitate comparisons in the chart below, Short has adjusted the Q Ratio and P/E10 to their arithmetic mean, which he represents as zero. The percentages on the vertical axis therefore show the over-/undervaluation as a percent above the mean value (i.e. his surrogate for fair value).

Based on the latest S&P 500 monthly data, Short concludes that the benchmark is overvalued by 59%, 42% or 37%, depending on which of the three metrics you choose.

Indeed food for thought …

Click here or on the graph below for a larger image:

Source: dshort.com, December 10, 2010.