DOW 21,000 : What’s Next and Its Valuation

March 02, 2017

I think it is time for me to update the world major stock market’s valuation by “ Regression to the Mean ” after DJ exceeded 21,000 marks in such a short period after hitting 20K level.

Always remembered that “ Reversion to mean “ is just a “statistical phenomena “ and it may take much longer time to “reverting to mean” if the market is in bubble or irrational stage.

As renowned economist John Maynard Keynes famously commented, “The market can stay irrational longer than you can stay solvent.”

Please find the link to my previous blog post about this topic (here ) " Regression Line For Major Stock Market Indexes."

“When the US (market) sneezes, the world (market) catches a cold !! “. Some may argue that there is a tendency and increasing of divergence between developed and emerging market, but with such an intertwined world economy and huge movement/flow of fund within a click , the high correlation of market movement when we are in panic and distress the situation shall prevail.

Well, nobody really know if Dow Jones would shoot up to 30,000 in the near term but one will really need to always set aside some “war-chest “ and get ready to take advantage of the market’s mood suddenly changes and swing from extreme optimism to pessimism.

Base on valuation by “ Linear Regression “, the STI and Hang Seng are at about "long term mean level" with exception to Japan’s Nikkei which is on the other direction of well above the mean level ( crossing +2SD level ). It might be due to the extremely loose “ monetary policy “ and Government’s fund in buying up the Index ETF.

Below article from Bloomberg clearly explained how BOC’s action in ETF buying program affecting Japan's Nikkei Index :

The Bank of Japan's Unstoppable Rise to Shareholder No. 1 (here )

(BOJ set to become the top owner of 55 firms in the Nikkei 225)

On the other hand, US and European market seems at high side except for FTSE100, with S&P, DJ and NASDAQ closed above +1SD level ( where NASDAQ is approaching +2SD level)

Is the Stock Market ( US ) Cheap?

From ( Advisor Perspective: Article contributed by Jill Mislinski ) :

The Valuation Thesis

A standard way to investigate market valuation is to study the historic Price-to-Earnings (P/E) ratio using reported earnings for the trailing twelve months (TTM). Proponents of this approach ignore forward estimates because they are often based on wishful thinking, erroneous assumptions, and analyst bias

Here is the latest update of a popular market valuation method using the most recent Standard & Poor's "as reported" earnings and earnings estimates and the index monthly average of daily closes for the past month. For the earnings, see the table below created from Standard & Poor's latest earnings spreadsheet.

TTM P/E ratio = 23.8
P/E10 ratio = 29.0

< Concept explained: from Advisor Perspective :

TTM P/E Ratio

The "price" part of the P/E calculation is available in real-time on TV and the Internet. The "earnings" part, however, is more difficult to find. The authoritative source is the Standard & Poor's website, where the latest numbers are posted on the earnings page.

The table here shows the TTM earnings based on "as reported" earnings and a combination of "as reported" earnings and Standard & Poor's estimates for "as reported" earnings for the next few quarters. The values for the months between are linear interpolations from the quarterly numbers.

The average P/E ratio since the 1870s has been about 16.7. But the disconnect between price and TTM earnings during much of 2009 was so extreme that the P/E ratio was in triple digits — as high as the 120s — in the Spring of 2009. In 1999, a few months before the top of the Tech Bubble, the conventional P/E ratio hit 34. It peaked close to 47 two years after the market topped out.

The P/E10 Ratio

Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behaviour during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market's value, which they discussed in their 1934 classic book, Security Analysis.

They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by a multi-year average of earnings and suggested 5, 7 or 10-years. In recent years, Yale professor and Nobel laureate Robert Shiller, the author of Irrational Exuberance, has popularized the concept to a wider audience of investors and has selected the 10-year average of "real" (inflation-adjusted) earnings as the denominator. Shiller refers to this ratio as the Cyclically Adjusted Price Earnings Ratio, abbreviated as CAPE, or the more precise P/E10, which is our preferred abbreviation.

“Relative to the mean, the market remains quite expensive, with the ratio approximately 73% above its arithmetic mean and 87% above its geometric mean.” write the author.

At the end of his message, Jill Mislinski posted below remark :

The Prevailing Question...

Was March 2009 the beginning of a secular bull market? Perhaps, and certainly, the new all-time highs repeatedly set over the past year are conspicuous tick marks for the optimists. But the history of market valuations suggests a cautious perspective.

You may read the full article ( here ).

Some Market analyst or expert is quick to call for Dow 30,000 !! or even 50,000 !!!

1) Next Stop, Dow 30,000 from Baron.com ( here )

2) Wall Street Legend Predicts “DOW 50,000!” (here )

What do you think on the current market valuation of major indexes? Are you fully invested in equity or having some “war-chest “ ready to pick up any stocks in case the market goes south. Which camp are in: “optimism or pessimism “?

Cheers !!

Quote Of The Day :

“Wouldn't economics make a lot more sense if it were based on how people actually behave, instead of how they should behave?”
― Dan Ariely, Predictably Irrational: The Hidden Forces That Shape Our Decisions

Append below the Regression Line for major stock markets around the world :