This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Kass: Everybody in the Pool

  • The median price-to-revenue ratio of the S&P 500 is now at an historic high, eclipsing even the 2000 level.
  • The Shiller P/E is above 25, exceeding all observations prior to the late-1990s' bubble except for three weeks in 1929.
  • Market cap-to-GDP is already past its 2007 peak and is approaching the 2000 extreme. (This ratio is stretched at over two standard deviations above its long-term average.)
  • The implied profit margin in the Shiller P/E (denominator of Shiller P/E divided by S&P 500 revenue) is 18% above the historical norm. On normal profit margins, the Shiller P/E would already be 30.
  • If one examines the data, these raw valuation measures typically have a fraction of the relationship to subsequent S&P 500 total returns as measures that adjust for the cyclicality of profit margins (or are unaffected by those variations), such as Shiller P/E, price-to-revenue, market cap-to-GDP and even price-to-cyclically-adjusted-forward-operating-earnings.
  • Because the deficit of one sector must emerge as the surplus of another, one can show that corporate profits (as a share of GDP) move inversely to the sum of government and private savings, particularly with a four- to six-quarter lag. The record profit margins of recent years are the mirror-image of record deficits in combined government and household savings, which began to normalize about a few quarters ago. The impact on profit margins is almost entirely ahead of us.
  • The impact of 10-year Treasury yields (duration 8.8 years) on an equity market with a 50-year duration (duration in equities mathematically works out to be close to the price-to-dividend ratio) is far smaller than one would assume. Ten-year bonds are too short to impact the discount rate applied to the long tail of cash flows that equities represent. In fact, prior to 1970, and since the late-1990s, bond yields and stock yields have had a negative correlation. The positive correlation between bond yields and equity yields is entirely a reflection of the strong inflation-disinflation cycle from 1970 to about 1998.

The joyous swimmers have returned to the investment pool in numbers during the munificent climb from the market depths of 2008-2009.

Not only have traders and investors ignored the potential investment headwinds but they have rewarded the S&P 500 with a quantum increase in valuation. Though P/E ratios have risen on average only 2% a year since 1990, valuations have climbed by nearly 25% in 2013.

Where Are the Bubbles?

There has been a lot of bubble talk of late. That talk (and the very existence of those questioning bubbles) seems to many as a rejection that there is a stock market bubble at all.

In " 10 Laws of Stock Market Bubbles," I noted that the problem with bubbles is that if you sell stocks before the bubble bursts, you look foolish, but you also look foolish if you sell stocks after the bubble bursts.

I also concluded that the market is not yet a bubble; it is simply overvalued (maybe by as much as 10%).

If I were pressed, however, to express if and where the bubbles reside today, they likely exist in the extraordinary faith in the Fed and central bankers around the world to shoulder the responsibility of catalyzing economic growth and in the general notion that corporate profit margins (and thus the outlook for future corporate profits) are inflated and in bubble territory at about 80% above the long-term average over the past six decades.

Too High

To date, the aforementioned headwinds have been seen simply as opportunities for investors to buy more stocks on weakness.

Grandma Koufax used to say, "Dougie, investment trees don't grow to the skies."

To a rising chorus of self-confident and almost boisterous bulls, fueled by a nearly unprecedented and continuing market rally, the investment trees indeed appear to be rising into the sky.

The argument, gaining credence with every 10-handle move in the S&P 500, is that with short-term interest rates anchored at zero, there is no alternative. But as Tennessee Williams wrote, "There is a time for departure even when there's no certain place to go." For, at many points in history, regardless of yield, cash has been king.

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free


Chart of I:DJI
DOW 17,901.57 +127.93 0.72%
S&P 500 2,079.93 +14.63 0.71%
NASDAQ 4,813.0850 +37.7270 0.79%

Our Tweets

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs