The inexact science of market valuation

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di Finanza Operativa 13 Novembre 2018 | 13:00

A cura di Jack Forehand, Validea Capital Management
When it comes to market valuation, investors love certainty. They want to hear definitively that the market is cheap, or the market is expensive, and that they can use that information to predict where it is headed in the short-term. As a result, strategists that make these type of market calls (particularly the ones who do so on the negative side), can generate significant headlines and attention for themselves.
None of this does anything to serve investors, though. These simple headline grabbing takes on market valuation take an issue that can be very nuanced and try to make it simple, and as a result, the conclusions that are reached are almost always flawed.
Trying to use the market’s valuation to predict short-term outcomes misses two important points that should govern any analysis of market valuation.

  1. The valuation of the market is often very different depending on the metrics you use
  2. Market valuation is not useful is predicting short-term outcomes

 
Let’s tackle these one at a time.
The Arbitrary Nature of Market Valuation
There is a popular belief that the current market is very expensive. Look at the chart below, which shows the median price/sales of all stocks in our database since 2005.

Even after the recent pullback, we are still in the 88th percentile (stocks have only been more expensive 12% of the time during the period). And this has been a period of elevated valuations relative to the long-term, so if you looked at a longer-term chart, you would see even greater overvaluation.
It seems reasonable to conclude based on this data that the market is very expensive. But the price/sales ratio is only one of many ways to look at market valuation. The below chart looks at valuation using trailing twelve-month earnings.
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