Back in February, I posted an article about the current state of market valuation at that point in time. You can read the article here. Given that we are now 2 months ahead, maybe we should take a quick revisit at where the market valuation is at right now.
As an investor, I think it is prudent knowing what and where the current market valuation is heading as a source of information, even if you do not intend to use them for decision making purpose. I’ve received a few emails in recent weeks asking me whether I’m starting to turn bearish on the stock market. I think the answer to what I think is pretty irrelevant. What is important is knowing and understanding your own position in the market justifying instead of deluding yourself into believing that you are “investing” when you are or actually not.
With that, let’s see if there are any changes to the market valuation from where it were back then in February. I am going to use the same valuation metrics for easy comparison purpose.
1.) Market Capitalization to GDP (Buffett Valuation Indicator)
The market cap to GDP ratio, also dubbed the Buffett valuation indicator, is a long term ratio used to determine whether an overall market conditions is undervalued or overvalued. As the ratio suggests, a result that is greater than 100% is known to be overvalued while a value below 100% is know to be undervalued.
The ratio suggests 123.1% back then in the last quarter, and now it has increased slightly to 127.4% in this quarter. This simply implies that the valuation in this indicator is in bubble territory and the bubble is expanding in this quarter. The ratio is now above +2 SD and this is the first time that it happens over the last 50 years or so, only to be eclipsed by the great bubble in 2000.
2.) Q-Ratio (developed by Nobel Laureate James Tobin)
The Q Ratio is an indicator of the total market value divided by the replacement cost of the overall market. This is a little bit like measuring the Price to Book where the earlier was like the Price to Earnings. Again, anything above 100% represents overvaluation while anything below represents undervaluation.
No changes to this quarter from previous quarter. The current situation represents a ratio of 1.11 which indicates that the market is overvalued in terms of its replacement value, a concept that is almost similar to the book value.
3.) Regression To Trend
The regression trendline drawn through clarifies the secular pattern of a variance from the trend. Where the market is trending above the regression slope, they are known to be overvaluation while the converse is true.
The data shows that the inflation adjusted S&P Index price was 93% above its long term trend, down from 96% we’ve seen in the previous quarter. Nevertheless, there’s no doubt that the trend suggests overvaluation above the long term average mean.
In the previous article, I suggested that there may be a hype of speculating from the opening of the new accounts especially in the China and HK market.
Similarly, I’ve also seen many new investors coming into the market at this moment with the intention of investing for the longest term, but because for some reason they’ve landed in the market in the current situation, they have a “tendency need” to invest right now not bothering about timing the market consistently because a lot of proverbs have been saying that no one has the ability to do so.
But contrary, some of the decisions I’ve seen in recent times suggest that these are the same group of people that are not investing consistently based on their own earlier philosophy because they are partly afraid of being caught in the situations of a correction. In other words, these people entered into a position with the intention of holding for a long term but because recent market surge has a potential to earn them a 5% realized gain, they decide to sell first in favor of the gain and redeploy the cash to some other counters, using similar method.
I called this the half-half philosophy because I’ve been caught in the same position many times, and many more so when I first started investing. The thought of investing for the long term seems pretty cool to many investors out there but when there are unrealized gains staring right in front of your screen, it seems pretty foolish not to be locking in those profits when you can.
To me, this is outright speculation and I’ve done it many rounds previously and and even now. Notice just how many times the word price is being mentioned and nothing about the fundamentals of the business or valuation is being mentioned. This strategy is definitely not wrong but just don’t confuse them with investing.
In one of the books I’m reading right now in the “Intelligent Investor”, Benjamin Graham defined the difference between investing and speculating this way:
“An Investment Operation is one in which, upon through fundamental analysis, promises the boundary of where valuations are defined, safety of principal is compromised and an adequate return is projected. Operations not meeting these requirements are speculative in nature.”
Most of us are probably grown up to be able to make our own decisions. We can choose to play any strategy or games we like and that is our prerogative rights to do so. But having said that, we should do so with our eyes fully open and knowing the truth of the consequences. That is probably what investing in realities is all about.