For the last couple of years, market prognosticators have been predicting a market correction, Due, in part, to the Herculean efforts of the federal money printing machine; markets have avoided the dreaded “correction.”
But even the fed’s efforts may not be enough in 2014. Mark Hulbert from Market Watch brings us six ratios that indicate a correction is coming. You can read the entire article by following the link below.
For those of you who just want the pertinent facts, here you go.
“Here’s how the market stacks up to past market highs or tops according to these six valuation ratios.
1. Price/earnings ratio. Calculated by dividing stock price by earnings per share; This is perhaps the most widely followed of all valuation ratios. Based on the previous 12 months’ earnings, the S&P 500’s current P/E ratio is 18.6, which is higher than those that prevailed at 24 of the 35 bull market tops since 1900. (Data before 1957 are for the S&P Composite Stock Index, since the S&P 500 didn’t exist yet.)
2. Cyclically adjusted P/E ratio. This is the version of the P/E championed by Yale University Professor Robert Shiller, the recent Nobel laureate in economics. It is calculated by dividing a company’s stock price by the average of its inflation-adjusted earnings of the preceding decade. For the S&P 500, this ratio currently stands at 25.6, which is higher than what prevailed at 29 of the 35 tops since 1900.
3. Dividend yield. This is the percentage of a company’s stock price that is represented by its total annual dividends. Since this yield tends to fall as prices rise, and vice versa, the market should register some of its lowest readings near its tops. The S&P 500’s yield currently stands at 2.0 percent, which is lower than the comparable yields that prevailed at all but five of the bull market tops since 1900.
4. Price/sales ratio. This is calculated by dividing a company’s stock price by its per-share sales. Though it is lesser known, it still is championed by many investors because it is based on data that is less susceptible to manipulation than earnings. For the S&P 500, the price/sales ratio currently stands at 1.6, which is higher than the comparable readings that prevailed at all but two of the bull market tops since 1955, which is how far back data is available.
5. Price/book ratio. This is another lesser-known valuation indicator, calculated by dividing a company’s stock price by its per-share book value - an accounting measure of net worth. For the S&P 500, this ratio currently stands at 2.7, which is higher than all but five of the 28 bull market tops since the mid-1920s, which is how far back data is available.
6. “Q” ratio. This indicator is based on research conducted by the late James Tobin, the 1981 Nobel laureate in economics. It is similar to the price/book ratio, except that book value is substituted by the replacement cost of assets.
Tobin thought this to be superior, since he considered replacement cost to be a better reflection of a company’s net worth than book value, which is based on assets’ original cost, no matter how far in the past those assets were acquired.
The Q ratio currently is higher than what prevailed at 31 of the 35 past market tops, according to data compiled by Stephen Wright, an economics professor at the University of London, and Andrew Smithers, founder of the United Kingdom-based-economics-consulting firm Smithers & Co.
Now, none of us know when the markets will “correct” next. All we know is that it will happen as markets go both up and down. The key takeaway for you is that you need to structure your portfolio to protect yourself when markets go south, while gaining a reasonable amount of the up side when they do well.
How to do that is one of the secrets of successful retirement planning, and one of the ways we take care of our clients.
If you want to learn more, just give us a call.