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Does someone know something (again)?

A chart from dshort.com of the Q-Ratio suggests stocks are remarkably overvalued.

You won’t hear anything about it from the mainstream financial media or the Federal Reserve, but this chart is screaming “stocks are extremely overvalued.” Please visit dshort.com’s excellent overview Market Valuation: The Message from the Q Ratio for additional charts of the Q Ratio, a measure of stock market valuation.

Although the mainstream financial media is touting low price-earnings ratios and permanently rising profits as the backdrop for a permanently bullish stock market, this chart reveals that stocks are more overvalued now than they were just prior to the Great Crash of 1929. Only the bubble of the dot-com era reached a higher extreme.

There is literally no reason to be bearish on stocks, at least in the mainstream media (“don’t fight the Fed,” etc. etc.), and there is always a chance that overvalued stocks can become even more overvalued (the “party like it’s 1999″ phenomenon).

What’s remarkable about this chart is the consistency of the highs and lows going back 100 years: the tops and bottoms are within a few ticks of each other, except for the dot-com bubble and the current bubble, both of which were blown by vast expansions of credit, State backstopping/intervention and leverage.

It’s also interesting to note that the Federal government and the Federal Reserve intervened so massively that the market wasn’t allowed to fall to previous cyclical lows. That further suggests that when the market overcomes the forces of intervention, it might fall below previous lows in a counter-reaction.

But not to worry–that’s “impossible.”

Of Two Minds

Stock Market Casino Royale – S&P 500 is Overvalued by 100 Percent – Earnings do not Justify Current S&P 500 Levels. Financial Markets Setting up for Another Correction.

Posted by mybudget360

When I look at the S&P 500 like most people do, you would expect that this wide cross-section of companies in the U.S. would reflect an accurate measure of the true health of industries in our economy.  Yet the S&P 500 is fully disconnected from any historical measures of valuations.  It is startling to see people talk about the wild swings in the stock market as if this were somehow standard in a regular market.  The S&P 500 fell by a stunning 58 percent from the peak in summer of 2007 to the low in March of 2009.  But from March of 2009 to February of 2010 the market has rocketed back up by 63 percent.  This kind of massive market volatility is not indicative of a healthy stock market.  This is a symptom of a system that is having a really hard time valuing assets since much of the toxic financial assets are still lurking in the murky black box of many financial institutions.

Let us first look at the S&P 500 price to earnings ratio (adjusted for inflation):

Source:  Robert Shiller, www.multpl.com

130 years of data and each major financial crisis has sent the PE ratio falling between the 5 and 10 range.  This crisis has kept PE ratios elevated to the point that the S&P 500 is still valued at twice of what it should be if we use moderate historical valuations.  And if we measure the bubble via earnings, valuations during this bubble got even more out of line compared to those prior to the Great Depression.  Yet in this crisis, valuations never made it down to a more realistic level.  This is endemic of our current financial system where market alchemy is suddenly supplanting any rational analysis of earnings and actual potential growth.

Take a look at inflation adjusted earnings:

Earnings have collapsed during this market turmoil yet the market is up some 63 percent.  What is the rally based on?  A lot of the rally is based on easy money flowing into financial institutions that are using their black box to make trades and maneuver around accounting rules to make out with billions in profits while the real economy is mired in real fundamental problems.  And this is easy to see since all you need to do is look at how consumer credit has contracted over the crisis:

Now ask yourself the following question; if we are a consumption based society and a large part of our consumption is fueled by debt, doesn’t a massively contracting credit market mean people are spending less?  Of course.  The above chart merely reflects what average Americans are dealing with.  They are adjusting their household budgets to reflect stagnant wages or lost jobs.  They are battling with the reality that their homes are not worth what they once were during the halcyon days of the bubble.  Yet the stock market has rallied as if we are back to the heyday of 2007.

This rally is really something to behold:

The only other time we saw such a sharp drop and rally was during the Great Depression.  Yet the depression dragged on for over a decade and here we are less than one year from the bottom of this market correction and all of a sudden we expect the market to be valued at these levels with no justification from actual earnings?  It just doesn’t make any financial sense.  We are back to seeing bubble like behavior.

Middle class Americans are largely not participating in this rally.  Clearly banks aren’t lending anymore even though they clamored for additional funds to provide credit to Americans.  The home loans banks are making are all backed by the U.S. government which only adds further fuel to the flame.  If you really want to see what sector by and large has benefitted the most from this rally, just look at the financial sector:

While the S&P 500 is up 63 percent and that in itself is stunning, the financial sector index is up a stunning 173 percent in this same period.  Have the banks really gotten that much better?  Is credit really flowing from their doors?  Not really but banks have managed to take taxpayer money and funnel it back into the stock market that is largely becoming more and more like a casino.  The structure is setup for quick profits even if it means long-term destruction for our economy.  Why try giving a boring 30 year fixed mortgage and earn a modest fee, even though the client will be better off in the long run when you can dish out a toxic mortgage with a high commission but will eventually lead the borrower to ruin?  That is the structure of our current financial system and nothing has really changed even though we have seen the most volatility since the Great Depression.

The current stock market valuation tells us that the stock market will hit another correction.  Short of incomes going sky high or earnings doubling each subsequent quarter, at a certain point valuations need to come back down to Earth.  Ironically the low reached in March of 2009 actually reflected a more sensible valuation of the economy.  Right now the S&P 500 is betting that things are back to the good old days but clearly this is not the case.  We should now be absolutely cautious when people try to value stocks or assets on potential values and not what reality is currently reflecting.

The Formula for This Market Rally In Simple Terms

Written by Graham Summers   

I’m about to share with you the basic outlines for this market rally started March 2009. In no way shape or form am I providing official recommendations or investment advice in this post. I am merely pointing out the obvious trends that this rally has followed.

 The first, most obvious trend is the Manic Mondays trend. I’ve commented on the weekly Monday ramp job that has been occurring in the markets for months now. However, Dr. Robert McHugh as done extensive analysis on this trend, showing that for the 43 weeks ended Friday January 8, 2010, stocks have rallied on 30 out of the 43 Mondays.

 Even more significantly, these Monday ramp jobs have contributed the bulk of the market rally’s gains since March 2009. McHugh comments that all told, 80% of the gains stocks have posted since March 2009 have come on Mondays.

 The significance of this trend cannot be overstated. Someone (or several someones) has been pushing S&P 500 futures up virtually every weekend since this rally began. Since most Wall Street traders take their cues from the overnight futures market, this has resulted in massive gap ups on most Monday mornings.

 By the way, the “Monday effect” works even when the market is closed on Monday as yesterday’s action attested. All you need is a weekend and light futures trading to produce a Manic Monday.

The second trend that has dominated this market since the March 2009 bottom is the Bernanke Options Expiration juicing. In simple terms Ben Bernanke has shown a REAL preference for pumping money into the financial system on the exact week when options are expiring. I’ve bolded the expiration weeks in the table below. You’ll notice the LARGEST Fed moves have ALL occurred on expiration weeks.

 You’ll note that on non-expiration weeks, the largest Fed move was a $38 billion capital infusion. However, ON expiration weeks the SMALLEST move is $46 billion. And the largest expiration pump is a whopping $80 billion, which interestingly enough occurred during a time in which stocks were starting to break down. Interestingly enough, the SECOND largest Fed pump occurred in November another time in which stocks were breaking down.

 Coincidence?

 Options expiration week historically is a time of GREAT market manipulation as Wall Street traders try to push their positions into the black so they can close them out at a profit. For the Fed to be making its biggest infusions of capital on ALL of these dates is “a bit odd” to say the least. The fact it has occurred like clockwork for months makes this trend almost as regular as the Manic Monday Ramp Job.

 The final trend that has dominated this market is cousin to the Manic Monday Ramp Job. It is the Night Session Ramp Job. I’ve already mentioned this trend in previous essays so I’ll keep today’s comments short. The simple fact is that from September 13, 2009 until year-end, ALL of the stock market’s gains occurred in the over-night futures session from 4:00 ET to 9:30 AM ET.

 Tyler of ZeroHedge was the first to identify this trend and created the following graphic. It sums up this trend perfectly.

As you can see, for the last three months of 2009, the market basically traded sideways during the normal day session (9:30ET to 4PM ET). In contrast, the after hours futures market (4PM ET to 9:30AM ET) accounted for ALL stock gains.

 So there you have it, the three most dominant trends of this market rally. None of them are pretty. None of them involve fundamentals. And ALL of them are directly related to the Fed’s liquidity pump.

 Good Investing!

 Graham Summers