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Yes; Stocks Really Are Overvalued

Feb. 28, 2017 5:31 PM ETSPY, SH, SSO, VOO, SDS, IVV, DIA, QQQ, XLY, XLP, XLF19 Comments
Daniel Goldman profile picture
Daniel Goldman


  • Using RSI, there is an overbought signal at the daily, weekly, and monthly time scales.
  • According to market capitalization to GDP, stocks are again overbought.
  • Volume and volatility hold further clues.
  • This does not mean that there is an imminent threat of a crash or even a correction.
  • It does suggest that it is going to get increasingly difficult to eek out returns.

According to Warren Buffett, even though we keep reaching new record highs, the stock market is not in a bubble, and stocks are relatively cheap, taking into account interest rates. How true is this? Well, there are a few measures that we can use to check to see if stocks are overbought.

I honestly do not use RSI all that much, but it is a useful indicator, and I should use it more often. According to RSI analysis, the S&P 500 is absolutely overbought. It entered overbought territory around the 10th of February, and the signal exists on both the daily scale, the weekly scale, and the monthly scale. Currently (as of 3:15pm on Monday), on the value on the daily scale was above 80 and heading higher.

SPX stock chart created using stockchart.com

However, RSI is not the only method available. P/E is another method, but it is somewhat outdated. I prefer market capitalization to GDP. In a way, it is an aggregate P/E after all. Jill Mislinski did a nice analysis of this metric. Using this valuation, again stocks are overvalued. This is true if we look at the S&P 500 or the broader Wilshire 5000. In both cases, the valuation is higher than it was around 2007, and only slightly lower than it was around 2000.

Interestingly, Warren Buffett himself is saying that stocks are not overbought, even though the "Buffett" index that he has touted in the past is suggesting that they are.

Volume and Volatility

Aside from direct indicators, something else interesting showed up towards the end of Monday. First, volume appeared to be low. Volume for the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) was about 50 million, as opposed to 82 million the day before, and 62 million last Wednesday, a day that saw a tighter candlestick than we saw today. In addition, volatility

This article was written by

Daniel Goldman profile picture
I am an occasional investor/trader and researcher. I use a combination of market theory and economic theory to determine my trading strategies, but focus on periods where contrarian actions seem reasonable, such as when market expectations seem to be trending in the opposite direction as fundamentals. Research Topics I am interested in the relationship between pattern day traders and investors and how value flows between these two groups.

Analyst’s Disclosure: I am/we are short SH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

I also have an overall contrarian position.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (19)

Nice article but in the end it is all about 'feeling'. Once enough people 'feel' they want to panic, the market will come crashing down. Now consumers 'feel' great about things. That will change at some point. People buy and sell stocks and people are not rational nor free thinkers for the most part....they are currently herding in and they will eventually herd back out.
Daniel Goldman profile picture
Good point. Sentiment absolutely drives the market. It just seems like there is far more downside risk than upside potential at this point, although ($ES) did spike overnight.
Avi Gilburt profile picture
GREAT point powercise . . . you clearly "get it," especially as most of the market pundits don't. The market is heading over 2500 . . yes, we will have pullbacks along the way, but all the fear being pushed is simply by those who are grasping for straws since their matrix did not expect this type of move. Pullbacks are buying opportunities until later this year.

One thing you may want to consider when reading analysis about the complex - did the pundit you read or hear on TV expect this rally to be seen from February 2016? If not, why not? And, if they have maintained their perspective that the market is simply "too high" during the entire ride up, that should tell you something.
I don't think it is just "feelings" or "market psychology". Since the beginning of 2016, the Fed and Central banks across the world have pumped $2.4tn into equities which supported a number of shocks that should have at least corrected the market last year. Now, remove $2.4tn from the market and think about where we would really be.

ECB - http://bit.ly/2mfsucp
China - http://bit.ly/2mMcTxz
Fed - http://bit.ly/2mfwERv

The Fed has injected $4.5tn dollars into the economy since 2008 and are now thinking of stopping.

Start to put the puzzle together, I think the euphoria that we are seeing right now is signal that this is now at the very top. Consequently, I don't see how anyone would argue that it is best to hold cash in reserves now that being in equities. But hey, greed is a very powerful thing. It will keep us locked in on hope that this goes even higher.
One thing nobody seems to talk about is actual core inflation. If there is 10% inflation within the next 3-4 years then that would bring all indicators to normal. And we see that the FED overshot the goal already, Trump suggested that he will print some money to pay debt, less tax also means more inflation, bringing back offshore money also means more inflation. There is plenty of other indicators that suggest we may see 10%+ inflation over the next few years. The current 17 P/E minus those 10% is 15 P/E which brings us back to normal. You can even go further and study stocks that are more dependent on different types of inflation than others and see the pattern. The only thing that seems off is the high dollar value and the not-so-in-line gold price, but perhaps they will synchronize at some pint and hey are lagging due to fear of interventions from state actors.
Daniel Goldman profile picture
Maybe I should write an article focusing more heavily on market cap to GDP. Hmm.

Assuming that the S&P 500 does not grow, given a 122% market cap to GDP ratio, getting back to 80% would require a roughly 52% increase in nominal GDP.

Let's say inflation is about 5% and that real GDP is growing at 3% (good luck even getting that), it would take five years. But again, that is assuming ZERO growth in market capitalization.
Yes I don't quite get it. I don't see why market cap to GDP is a valuable quantity. GDP is US-scoped, while the market cap is quite international so surely you need to adjust for the scope and size of different things.
Daniel Goldman profile picture
An interesting point, but then you reject Buffett's index totally. One would imagine that stocks and GDP are related. Perhaps a fun metric to use would be something like the Wilshire 5000 to global GDP. If I can find that data, maybe I'll give it a look.
Skipped a few days, just came back to revisit this site. I am amazed of the low quality of the articles. How can articles like this one be allowed to publish here?
Daniel Goldman profile picture
I am sorry that you are displeased with the article. What about it do you find to be low quality?
TDune75 profile picture
Well, to start with, the author states, "Interestingly, Warren Buffett himself is saying that stocks are not overbought, even though the "Buffett" index that he has touted in the past is suggesting that they are."

Most other authors on SA would have posted a chart of the Buffet index, which bye-the-way, is total stock market capitalization versus GNP. Oh, right, everyone reading SA should already know that.

I could go on, but trust I've made the point raised by xpan.
Daniel Goldman profile picture
"I prefer market capitalization to GDP. In a way, it is an aggregate P/E after all. Jill Mislinski did a nice analysis of this metric. Using this valuation, again stocks are overvalued."

While I did not just copy over the article, because I am apparently more wary of copyright issues than some authors, I did link directly to a full analysis.
Babbage profile picture
I'm not a permabull, and my investing strategies tend to ignore market trends, but I'm with Buffett on this one. Barring some catastrophe, perhaps a nationalism-fueled trade war or worse, the market's going to keep creeping slowly up as long as inflation remains tame and (consequently) interest rates stay low. They don't have to stay super low, just low enough that Buffett is right -- low interest rates make higher PE ratios rational. We can forget about that old saw that 15% PE or lower is really needed. Reading around this topic makes a fairly compelling argument for why we've continued making new highs for the past 12+ months, flying in the face of all those (like you Daniel) saying "I'm not saying a crash is imminent, but..." I've been hearing that at least since we were making new highs back in 2014 and 2015, let alone last year and now. There's nothing big enough wrong with the U.S. economy to trigger a big stumble on its own, and the market is nowhere near pricing a possible decade ahead with low interest rates. Trade wars? Sure. Real wars? Yep. Externalities could do it, but they can cause a market tumble anytime. I'm still in a bull market now.

All that said, I value BuyAndHold 2000's reading opinion and position. I took his advice a few months ago and bought some Disney when it was getting low enough to be nearing his own trigger (don't think it ever got there, likely, but it was low enough for me). The best way to lower your risk is to buy stock at a low price relative to its value. Market valuation as a whole be damned, there's always some individual stock getting beat down near to that level.
Leave The Gun, Take The Cannoli profile picture
Goldman Sack predicted the following "selected" stocks were most overpriced back in January 2016.

1. BA : $144 ( 01/2016) - $180 (02/2017) = +52%
2. INTC : $33.45 ( 01/2016) - $36.20 (02/2017) = +22%
3. NVDA : $32.96 ( 01/2016) - $101 (02/2017) = +223%

Daniel Goldman profile picture
Good point. As I mentioned, just because a stock is overvalued does not mean that it will go down. However, it does increase and make gains harder to obtain.

I'm also not sure what method Goldman used to make their assessments.
Makes one think, that in Jan 2016, GS didn't see any investment banking deals possible with these firms.
Do not disagree with your analysis but interesting that Buffett just declared stock picking dead and you just declared index investing dead.
Daniel Goldman profile picture
I have to admit, I feel a little anxious about suggesting that Buffett is dead wrong. I feel like stock picking was dead, because there was really little need to do anything but follow the trend, when valuations were on their way up, but if we really are overvalued, then just going with the flow won't do much, and it could open oneself up to a lot of downside risk.
Buyandhold 2012 profile picture
I can not come up with many stocks worth considering buying at this time.

Target, Qualcomm, Amgen, AbbVie, Teva, Nike, ABC, VFC, Apple, Pfizer, Novo Nordisk, Gilead.

That's about it. The stock market, in general, is extremely overpriced.
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