By Andrew Smithers, chairman of Smithers in London and author of Wall Street Revalued: Imperfect Markets and Inept Central Bankers, Wiley, September 2009
Following its dramatic bounce since early March, the stock market is back into overvalued territory. As of Oct. 13, with the
index at 1071, it was 41% overvalued according to
q and 38% according to CAPE (cyclically adjustedprice-to-earnings ratio).
The rise was set off as economic news proved to be less dire than expected. This led to a reversal of the pattern of the previous decade. Companies, which had been massive net buyers of equities, became net issuers, while individuals, who had been steady sellers, became buyers.
The ratio of liquid assets to quoted share holdings, including mutual funds, fell from 93% to 81% and would have fallen further but for asset buying by the
, which bought $800 billion of assets from the private sector, thus boosting liquidity.
Asset prices tend to move either because of altered views on economic prospects or through changes in liquidity. When expectations for growth improve, equities tend to rise, while bonds fall and gold rises if inflation is seen as a rising threat. Virtually all asset prices have risen recently, which points to improved liquidity as the key cause. Liquidity equal to over 5% of U.S. GDP and over 8% of U.K. GDP has been injected by central banks.
Share prices could continue to rise, either because the flow of news continues to be better than expected or because even more liquidity is injected by central banks. The chances, however, of news being better or worse than expected are naturally around even and, at some stage, central banks will have to sell the assets they bought. While they are in no hurry to do this, they seem to have stopped adding to their holdings.
I think therefore that the prospects for the equity market are poor.
Andrew Smithers is the founder of Smithers & Co., which provides economics-based asset allocation advice to over 100 fund management companies worldwide. Andrew is a regular contributor in Japan to the Nikkei Veritas. He was a regular contributor to the London Evening Standard and Japan's Sentaku magazine, and has written for many other newspapers and magazines, including the Financial Times, Forbes (U.S.), Sunday Telegraph (U.K.), Independent on Sunday (U.K.) and Genron (Japan). Andrew is an invited contributor to the prestigious Economist's Forum on the FT Web site.