Party Like Its 1929
Todays market is markedly overvalued by the normalized P/E or Q ratio, as well as by Buffett's favorite metric, the ratio of total market capitalization to GDP. That ratio was recently about 1.3 against a long-term average near 0.62 and a long-term median of roughly 0.56.
Jeremy Grantham calls corporate profit margins the most reliably mean-reverting series in finance, and Buffett wrote that the margin (total aftertax corporate profits as a percentage of GDP) generally remains between 4% and 6.5%. He remarked that it's rare for the rate to go above 6.5%. However, that margin reached 7.92% last year, according to a report by Arnold Van Den Berg. That value was exceeded only once during the last 80 years--in 1929.
Too much importance has been assigned to unsustainable current conditions, and too little attention has been given to normalized estimates of profit margins, interest rates, and earnings growth. Just as independent-minded investors with a long-term focus profited by recognizing that bad conditions were likely to improve in 1979, like-minded investors today should heed the warning flags the market is waving: The normalized P/E, Q ratio, and market-capitalization/GDP ratio are unsustainably high.
Morningstar: Outsmarting Market Trends
Jeremy Grantham calls corporate profit margins the most reliably mean-reverting series in finance, and Buffett wrote that the margin (total aftertax corporate profits as a percentage of GDP) generally remains between 4% and 6.5%. He remarked that it's rare for the rate to go above 6.5%. However, that margin reached 7.92% last year, according to a report by Arnold Van Den Berg. That value was exceeded only once during the last 80 years--in 1929.
Too much importance has been assigned to unsustainable current conditions, and too little attention has been given to normalized estimates of profit margins, interest rates, and earnings growth. Just as independent-minded investors with a long-term focus profited by recognizing that bad conditions were likely to improve in 1979, like-minded investors today should heed the warning flags the market is waving: The normalized P/E, Q ratio, and market-capitalization/GDP ratio are unsustainably high.
Morningstar: Outsmarting Market Trends
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