Are Stocks Expensive? BofA doesn’t think so, I do.

Below are 15 different metrics provided by BofA Merrill Lynch U.S Equity and U.S Quant Strategy division. The time interval is provided in the far right with the current reading in the far left. As you can see most of the metrics used below are below average as well as median values, with the exceptions of the Shiller P/E, Price to operational cash flow, Equity Risk Premium (ERP),  and normalized ERP.

The above average ERP can be attributed to record low rates and the ZIRP policy that was implemented. Operational cash flow could be getting ahead of itself, especially if sluggish inventory turns and payment collection is hampering the North American market rebound.

multiples BOFA
But the Shiller P/E is the most troubling of all (an inflation adjusted earnings metric) and signals the market may be as much as 40% over valued based on historic mean reversion. It is troubling that these types of “strategies” are released conspicuously, to say the least, to the public from investment banks.

Take total market capitalization divided by GNP (a similar metric) the picture starts to look a little more realistic to say the least.

2013 Q1 GDP of 16,010.2 billion gdp

Wilshire 5000 as of Month end July 2013 the total market capitalization stood at 17,200.00

wilshire 5000
TMC17,200,000,000,000.00 / GDP16,010,000,000,000.00 = 107% 

This would show that the total market capitalization of America is 7% higher than U.S total GDP. With estimates of GDP growth ranging from 2-4% in coming years, we are already a few years ahead of ourselves and there is a very high probability at some point in the future we will be trading below where we are currently. Most metrics provided by BofA paint a rosy picture but when you look at the Shiller P/E it sticks out like a sore thumb and corroborates with “Warren Buffett’s favourite indicator” the TMC/GNP.

This is the time to be a realists and acknowledge that future market returns (on average) will not provide positive real returns. Although each individual company is different and is priced by Mr. Market different each day, some individual bargains may be found, but in cumulative, North American equities are a losing bet right now. The warning signal does not say markets will fall tomorrow, next week or even next month but simply that markets are priced beyond perfection based on current GDP.  Here are links to the 1999 & 2001 articles from Buffett.

—> 1999

—> 2001

“Once a bull market gets under way, and once you reach the point where everybody has made money no matter what system he or she followed, a crowd is attracted into the game that is responding not to interest rates and profits but simply to the fact that it seems a mistake to be out of stocks. In effect, these people superimposed an I-can’t-miss-the-party factor on top of the fundamental factors that drive the market. Like Pavlov’s dog, these “investors” learn that when the bell rings–in this case, the one that opens the New York Stock Exchange at 9:30 a.m.–they get fed.”

Note: July 31st Market Capitalization used with official Q1 GDP as official Q2 GDP is not available currently. 


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