Stock overvalued at levels never before seen

The stock market rally coming off March lows has now surpassed 60%, a rally of strength rarely seen before. But it has been seen before, so let's put it into perspective.

* Year over Year Retail Sales: 9.3% average in prior 60% rallies versus -5.3% in the current one
* Consumer Confidence: 95.5 average; 53.1 now
* Capacity Utilization: 79.9% average; 66.6% now
* Year over Year Industrial Production: 4.1% avereage; -10.7% now
* ISM: 53.9 average; 52.6 now
* Payroll employment gains over period: 2.2% average; -2.0% now
* Decline in continued unemployment claims from cycle peak: -26.3 average; -11.6% now
* Year over Year growth in total credit market debt: 9.3% average; 3.0% now
* Year over Year growth in household debt: 8.8% average; -0.1% now
* P/E Multiple: 16.8x average; 20.0x now

In other words, the fundamentals cannot justify this rally.
But these aren't the only ways that you can measure this rally. Another way to do it is on a relative basis based on its recent performance.

On the valuation front, stocks are presently overvalued, but to levels that we've observed at least several times in history. The anomaly relates to market action, where we can no longer find a single historical instance where stocks were more overbought on the combination of short- and intermediate-term measures we respond to most strongly. Indeed, only one instance comes close, which is November 28, 1980.

That date is not very well known, mostly because it was so short-lived. The rally was coming off the 1980 recession and was based on "less bad" news, much like today's. That rally quickly died as the country headed into the 1982 double-dip recession.

As for the present, we have rarely seen 90% of stocks suspended above their 50- and 200-day moving averages for as sustained a period as we have now observed.

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Asset price bubbles.

It's illusory. Make it feel like things are going well by providing trillions in liquidity and this time the place for all that cheap money is the stock market. But hey, LEI will show an increase because of the stock market and everything will seem OK.

The stock market is reflexive - there is a built-in feedback mechanism where perceptions and information is reflected back into itself often times ignoring reality.

RebelCapitalist.com - Financial Information for the Rest of Us.

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I guess I am old fashion

but the other thing is the quality of earnings. Many of these profits are based on cost cutting. Look at Catepillar it made its profits based on inventory and capacity cuts. Now, they say that things have bottomed out - we will see. Certainly, a lower dollar will help them overseas but they have probably cut to the bone.

RebelCapitalist.com - Financial Information for the Rest of Us.

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That's not quite so clear

The issue may be more one of quality as Rebel Capitalist says, rather than absolute value. Hussman's evaluation is far more sophisticated than anything I can do, but based on the actual numbers it would seem no so severe. Annualized "operating earnings" at the end of q2 were $55.24 for a 20x multiple based on current pricing and using the projected numbers for q3, the annualized multiple is 18x. Not hugely overinflated by market standards. But the quality of those earnings is key. Corporations got there by slashing staff, closing plants and outsourcing jobs. In other words, just generally decimating the labor force. So revenue growth will come from where? PCE was up in the third quarter and credit was down. That creates an enormous squeeze on what's left of savings (which were way down in August) and is followed by epic fail in the economy. People need jobs in order for the economy to grow and corporations to earn profits, unless most of those earnings come from overseas sales and currency gains.

And then there is the issue of writedowns. Operating earnings are bogus for a lot of reasons, and reported earnings (which include writedowns) are more reflective of a company's health. But therein lies an interesting story.

Writedowns in the first quarter, with the economy contracting at a 6% rate, were $2.60 a share, or roughly equivalent to the writedowns taken in the fourth quarter of 2005, when the economy was running "full blast". Nothing wrong there!!!

When the results from the second quarter were initially aggregated by the S&P, with the economy contracting at close to 1%, writedowns were $.02/share. You need to go a long way back in the historical record to find that kind of a trivial difference.

Somebody must have let the CEOs know that they were all swimming with their shorts down. Since then the difference has ballooned up to $.30/share due to "adjustments". Between you and me a $.28/share adjustment to the aggregated S&P500 earnings is not a trivial change. It would seem that the Federal Government is not the only organization that adjusts its numbers for initial reporting purposes.

The real question is how long the pretense can be maintained or, as a corollary, how long is the collective memory of the Big 4 accounting firms? (anyone remember Arthur Anderson?) [FYI, Writedowns in the fourth quarter of 2002, a full year after the end of the 2001 recession, but just 6 months after AA went down in flames were much, much larger than in 2001.] The shysters can keep this going for a long time if their accountants have short memories. I suspect there will be some reckoning in the fourth quarter, but nowhere near as much as it should be. That will push "as reported" P/E into the upper 20s; definitely bubble territory, but nowhere near the upper 40s seen at the height of the tech bubble. But given that the consumer is gone and jobs are gone, the whole thing could unravel in 2010.

Sorry for the long comment.

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Excellent points

I'd like to add to them.
#1) Domestic equity mutual fund outflows reached $25 Billion in August. This makes no sense when you consider the major market moved 7% higher that month. In fact, every week of September and so far in October has seen steadily increasing outflows, with the week of October 14 hitting a high of $5.3 Billion.

#2) On valuations:

The S&P 500 Index is now selling at 26 times operating earnings. That's more expensive than the bull market top in 2007.

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