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ValuEngine.com: Valuations Remain Elevated But "Normal"

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Valuations Remain Elevated But "Normal"

ValuEngine tracks more than 7000 US equities, ADRs, and foreign stock which trade on US exchanges as well as @1000 Canadian equities. When EPS estimates are available for a given equity, our model calculates a level of mispricing or valuation percentage for that equity based on earnings estimates and what the stock should be worth if the market were totally rational and efficient--an academic exercise to be sure, but one which allows for useful comparisons between equities, sectors, and industries. Using our Valuation Model, we can currently assign a VE valuation calculation to more than 2800 stocks in our US Universe.

We combine all of the equities with a valuation calculation to track market valuation figures and use them as a metric for making calls about the overall state of the market. Two factors can lower these figures-- a market pullback, or a significant rise in EPS estimates. Vice-versa, a significant rally or reduction in EPS can raise the figure. Whenever we see overvaluation levels in excess of @ 65% for the overall universe and/or 27% for the overvalued by 20% or more categories, we issue a valuation warning.

We now calculate that 60.99% of stocks are overvalued and 23.14% of those stocks are overvalued by 20% or more. These figures have been fluctuating with increasing volatility, but have pretty much been pinned in this range for much of the past few months. We did our last valuation study on February 26th, and at that time we were within the same narrow range. As was the case then, these figures are down significantly from where they were for much of 2014.

As is always the case with this unprecedented rally, the market remains beholden to Janet Yellen and the Fed's rate raising schedule. Good news for the economy may paradoxically be bad bad for equities under these conditions. Bad news may provide a mini boom.

Despite recent poor GDP figures, we still find an improving labor situation which should finally bolster the recovery. We have also seen a remarkable recovery in the oil markets as US producers have reacted to Saudi attempts to crush them via low prices with agility and speed. That was bad news for speculators counting on low oil prices, but could be more beneficial to employment in places like Pennsylvania, Ohio, Texas, Oklahoma, etc. The quick reduction in drilling activities hurt workers and local economies, but a price recovery will mean a faster return for that industry.

We still find it more likely that the Fed will focus on employment rather than inflation (although that remains low as well) as it sets its rate increase schedule, and thus believe that equities may still remain the only game in town for a bit longer than many expected even a few months ago. Of course, the long hard winter for many areas of the US is now over. That brings to the forefront the long-held trader's maxim of "Sell in May and Go Away." Will that hold sway this year? Stay tuned.

The chart below tracks the valuation metrics from January 2015. It shows levels in excess of 40%.

This chart shows overall universe over valuation in excess of 40% vs the S&P 500 from January 2014

This chart shows overall universe under and over valuation in excess of 40% vs the S&P 500 from March 2007*

*NOTE: Time Scale Compressed Prior to 2011.