The Great Disconnect: Stocks 30% Overvalued and Still Going Up ... and Housing Rolling Over
Posted Mar 25, 2010 11:16am EDT by Henry Blodget in Investing, Recession, Banking, Housing
Related: dia, spy, ^dji, ^gspc, xlf, xhb, From The Business Insider, March 25, 2010:
We don't mean to rain on the stockmarket parade (we're enjoying it, too), but we'll confess to being astonished by it.
We understand that the world's governments are pumping money into their economies. We understand that that money has to go somewhere. We understand that, right now, that somewhere is often stocks.
We also recognize that the stock market is "forward looking," meaning that stock investors couldn't care less about 10% unemployment and other depressing facts about the economy. As far as stocks are concerned, as long as the situation is improving, it doesn't matter how bad the present is.
But we're looking forward, too, and here's what we're seeing:
The housing market, a huge engine of the U.S. economy via both direct spending and the wealth effect, is rolling over and heading for a double-dip. This despite the fact that the government is still spending money hand over foot to keep house prices propped up.
In a week or so, the Fed is supposed to begin withdrawing some of this housing subsidy by winding up its mortgage-buying program. The Fed may or may not actually do this, but if it does, this move could further depress the housing market. And that, in turn, could put more pressure on strapped consumers who can no longer borrow from home-equity lines to fund current spending, no longer feel rich, don't have much borrowing capacity, and, often, no longer have jobs. (And consumers still account for more than 70% of spending in the economy).
A falling housing market will also likely lead to more underwater homeowners, more "shadow" inventory, more foreclosures, more pressure on house prices, and, possibly, more bank write-offs. The more banks are worried about future write-offs, the less likely they are to lend, and bank lending has already fallen off a cliff.
So, basically, we think the apparent double-dip in the housing market is a big deal, and we're surprised that the market is whistling Dixie in the face of it.
If stocks were cheap, we wouldn't worry about it. We would just assume that the market was so forward-looking that it was gazing beyond the double-housing-dip to the eventual recovery. But stocks aren't cheap. In fact, measured using our favorite valuation technique, Professor Robert Shiller's cyclically adjusted PE analysis, they're getting downright expensive.
Check out the chart below, from Professor Shiller's web site. The blue line is the cyclically adjusted PE ratio for the last 130 years.
Note a few things:
The long-term average for the cyclically adjusted PE is about 16X. Obviously, that's only an average.
Stocks have spent vast periods above the average and vast periods below it, usually in multi-decade cycles
We've just descended from the longest period of extreme overvaluation in history, suggesting (to us, anyway) that the next multi-decade cycle is likely to be below the average
At today's level, 1160 on the S&P, stocks are trading at a 21X CAPE, about 30% above the long-term average
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