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With this in mind, we will review the current market valuations. We have always published a monthly valuation article by Jacob Wolinsky. Some of the charts in this article are also used by Jacob in his article.
If you don’t know, GuruFocus hosts two pages about market valuations. The first is the market valuation based on the ratio of total market cap over GDP; the second is the measurement of the U.S. market valuation based on the Shiller P/E. Both pages are updated at least daily. By the way, we will also create a new page for international markets. The page will cover European, Asian and South American markets. It will be released in less than a month. Stay tuned if you are interested in international markets.
Why is this important?
As pointed out by Warren Buffett, the percentage of total market cap (TMC) relative to the U.S. GNP is “probably the best single measure of where valuations stand at any given moment.”
Knowing the overall market valuation and the expected market returns will give investors a clearer head on where we stand for future market returns. When the overall market is expensive and positioned for poor returns, the overall market risk is high. It is important for investors to be aware of this and take consideration of this in their asset allocation and investing strategies.
Please keep in mind that the long-term valuations published here do not predict short-term market movement. But they have done a good job predicting the long-term market returns and risks.
Ratio of Total Market Cap over GDP - Market Valuation and Implied Returns
The information about the market valuation and the implied return based on the ratio of the total market cap over GDP is updated daily. Currently, the stock market is fair valued. Based on the historical ratio of total market cap over GDP (currently at 87.4%), it is likely to return 5.7% a year from this level of valuation.
For details, please go to the daily updated page.
Total Market Cap and U.S. GDP:
The Ratio of Total Market Cap to U.S. GDP
The Predicted and the Actual Stock Market Returns
The current implied return is 5.8% a year over the next eight years. This is never a precise number, however. If the market climbs up to the high end of its historical valuation, the return can be as high as 10.8% a year. If the market goes to the low end of its historical valuation, it may end up with negative returns for the next eight years.
The highest implied return for the U.S. stock market was at March 2009, when the ratio of total market cap over GDP implied an annual 12.5% gain over the next eight years.
Shiller P/E - Market Valuation and Implied Returns
The GuruFocus Shiller P/E page indicates that the Shiller P/E is 20.7 as of today — 26.2% higher than its historical mean of 16.4. The implied annual return is 3.9% over the next eight years, which is slightly bearish than the prediction of the ratio of total market cap over GDP. The Shiller P/E chart is shown below:
Over the last decade, the Shiller P/E indicated that the best time to buy stocks was March 2009. However, the regular P/E was at its highest level ever. The Shiller P/E, similar to the ratio of the total market cap over GDP, has proven to be a better indication of market valuations.
Overall, the current market valuation is more expensive than the most part of the last 130 years. It is cheaper than most of the time over the last 15 years.
To understand more, please go to GuruFocus' Shiller P/E page.
John Hussman’s Peak P/E
John Hussman uses the peak P/E ratio to smooth out the distortion of the corporate profits caused by the fluctuations of the profit margins. The current market return projected by his model is below 5% a year. This agrees with the returns projected by the ratio of total market cap over GDP and Shiller P/E. This is the chart of the actual S&P 500 10-year annual total return and the projected return by John Hussman:
Best Buying Opportunities Confirmed by the Insiders
As indicated by the three different approaches discussed above, the best buying opportunities over the last five years appeared when the projected returns were at their highest level from October 2008 to April 2009, when investors can expect 10% a year from the U.S. market.
If average investors missed this opportunity, corporate insiders such as CEOs, CFOs and directors did not. As a whole they purchased their own company shares at more than double the normal rate from October 2008 to April 2009. Many of these purchases resulted in multi-bagger gains. This confirmed again the conclusions of earlier studies: The aggregated activities of insiders can serve a good indicator for locating the market bottoms. Insiders as a whole are smart investors of their own companies. They tend to sell more when the market is high, and buy more when the market is low.
This is the current insider trend for S&P 500 companies:
The latest trends of insider buying are updated daily at GuruFocus' Insider Trend page. Data is updated hourly on this page. The insider trends of different sectors are also displayed in this page. The latest insider buying peak is at this page: September of 2011, when the market was at recent lows.
Conclusion: The market is not cheap. It is positioned for about 4-6% of annual returns for the next decade. But by watching the overall market valuations and the insider buying trends investors will have a better understanding of the risk and the opportunities. The best time to buy is when the market valuation is low, and insiders are enthusiastic about their own company's stocks.
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