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Market valuation

One of the problems with evidence showing whether the market is "correctly" valued is that there are so many measures of market valuation. Trot out evidence based on a particular market statistic, say the Price-Earnings (P/E) ratio, and someone else will reply with an opposite conclusion using a different statistic.

I point that out merely to explain that in presenting information like what follows, we're not necessarily trying to build a case based on that information. In this case, I've got interesting information about the market potentially being undervalued. That doesn't mean we're saying everyone should race out and buy based on this information. It's just a single data point to ponder.

That said, I found this chart by Peter Brimelow and Edwin Rubenstein to be very intriguing.

You can read the whole article for the details, but the short version is this. Jeremy Siegel's 200-year data set for the stock market has found that returns have averaged a very consistent 7% real return (after inflation) since the beginning of the 1800s. Brimelow and Rubenstein take that average and chart how far above or below that long-term average the stock market currently is.

That data has showed extremes in valuation at data points that, in hindsight, did in fact prove to be market extremes. Examples include being 85% above the trend in 1999, and a remarkably similar 40% below trend in 1981, 41% below in 1974, and 42% below in 1932. Obviously all of those were key market highs and lows.

What does the data show now? Through January 14, their data shows the market 43.1% below trend. That's the farthest below the trend the market has ever reached in the 200 years of data available.

That's not to say the market couldn't go even further to the down side. What it does mean is that by this particular measure, extremes are being reached on the low side. In the past, when these types of extremes have been reached, there has been a strong tendency for the market to "revert to the mean," or move back towards the long-term trend line.

That would imply this is a strong buying opportunity in advance of a sustained market advance that would bring the market closer to the long-term trend line. But again, the timing is anything but certain. Still, it's worth noting for long-term investors.

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