You have to go all the way back to 1984 to find another time when the stock market was as undervalued as it is today, according to a unique dataset of high quality dividend-paying stocks.
This dataset to which I refer is maintained by an investment advisory service called Investment Quality Trends, founded in the 1960s by Geraldine Weiss and currently edited by Kelley Wright. (Full disclosure: It is one of the services that pays a flat fee to have its returns audited by my firm.) Twice each month over the past 50+ years, the newsletter has segregated a group of several hundred dividend-paying stocks into four categories according to where their dividend yields stand relative to their historical ranges.
One of these categories -- the Overvalued category -- was found by my econometric tests to have statistically significant ability to forecast the S&P 500’s returns. A lower percentage of stocks in that category was correlated with higher subsequent stock market returns, and vice versa -- as you can see in the accompanying chart.
This is good news, since the percentage of stocks in this category fell at the end of March to one of its lowest levels in decades. In fact, Wright told me in an interview, the last time there was a lower percentage was in 1984 -- more than 35 years ago.
You may recall that I wrote about this Investment Quality Trends dataset in a column last June. Though the market is a lot more undervalued today than it was then, I reported that it was somewhat undervalued even then. The S&P 500 rose more than 17% over the next 8 months, before its recent bear market. Even in the wake of that bear market, the S&P 500 is slightly higher today than it was when that column appeared.
To be clear, Wright does not recommend using his data as a short-term market timing tool. In fact, he says he has no idea whether or not the bear market bottomed at its March 23 lows. He adds that only a speculator cares, stressing that for his part he finds the "discussion utterly ridiculous."
Nevertheless, Wright wrote in the most recent issue of his newsletter, "Clearly, good… values abound. What everyone is trying to decide though is whether those good values will get even better. That, my friends, is speculation. No one knows how long it will take for the economy to emerge and recover. There simply is no contemporary precedent that provides an answer to that question."
It was my idea to test whether the percentage of stocks in the newsletter’s "Overvalued" category had any forecasting ability.
According to the econometric model I constructed based on the size of this Overvalued category at each point back to 1966, the S&P 500’s expected price-only return over the next 12 months is 10.2%. Add in the index’s current 2.0% dividend yield, and you get an expected total return of 12.2%.