Market Metrics: Are We In a Bubble?

Posted on May 11, 2014 by

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A look at some of the important quantitative metrics that influence the stock market.

July 24, 2014 Commentary

Positive outlook, but…

Overall, our metrics continue to indicate a positive outlook for the market.

However, one of our key measures has shifted from “neutral” to “bad” and this one is especially worth examining because it supports some of the recent talk suggesting that we’re in a bubble.  The metric, S&P 500 earnings to price change, compares how much earnings have gone up to how much stock prices have changed.  In a normal situation we’d expect this ratio to be near 1.0 — indicating that revenue and price are moving in step.  The value is 0.63 which indicates prices are moving up much faster than revenues.  This may indicate an overvalued stock market.

Are we reaching the top of a bubble?

David Leonhardt at the New York Times suggests that we may be:

While the rest of economy has been growing frustratingly slowly for almost five years, stocks have been rising at a boomlike clip. An investment in the Standard & Poor 500-stock index would have doubled from early 2009 through early 2013 and then gained an additional 18 percent over the last year.

Relative to long-term corporate earnings – and more in a minute on why that measure is important – stocks have been more expensive only three times over the past century than they are today, according to data from Robert Shiller, a Nobel laureate in economics. Those other three periods are not exactly reassuring, either: the 1920s, the late 1990s and in the prelude to the 2007 financial crisis.

Here’s another article that states: “We’re in the third biggest stock bubble in U.S. history.”

On the other hand “well-known strategist and long-time bull Richard Bernstein scoffs at the notion equities are in a bubble and insists the biggest bull market of his career still has further to run.”

What’s the take home message?

The truth is probably somewhere between the two extremes.  Our metrics suggest a positive outlook for the market, but there are risks on the horizon.  In my opinion, the biggest risk ahead is a rise in interest rates.  See my commentary on this. When interest rates first begin to rise, I expect a sharp response from the market.  Until that time I think we’ll see a continued bull market.

Metrics summary

Of the 11 factors we track, two changed since our last update in May: Lucena’s macro economic model improved slightly, and S&P 500 earnings to price change declined slightly. We also saw improvement in the number of S&P 500 companies reporting losses (down to 17 from 20), but that was already a “good”. Taken together our factors score 7.7 out of 10 this week, indicating a positive long term outlook.

Stocks to watch:

Several of our metrics involve an assessment of all stocks in the S&P 500.  In the course of this assessment, we come across some stocks that stand out in one way or another.  Here’s a summary of those findings:

  • High price/earnings ratio: VNO.  VNO has been at the top of the list for two months. A high P/E ratio indicates the stock may be overvalued.
  • Low price/earnings ratio: PHM. PHM has been at the top of this list for three months. A low P/E ratio may indicate an undervalued stock.
  • High book/earnings ratio: NWSA. NWSA has been at the top of this list for three months running. A high book to earnings ratio indicates the company is not generating strong revenue compared to the value of their company assets and resources.
  • Low book/earnings ratio: WYNN. WYNN has been at the top of this list for three months. A low book to earnings ratio indicates the company is efficient at generating revenue.

Market & Economy Scorecard:

Factor Value Impact Score
Lucena’s Macro Economic Model 10.0 Good 1.00
S&P 500 earnings to price change 0.63 Bad 0.00
S&P 500 book to earnings ratio +4.0% Neutral 0.50
S&P 500 companies reporting losses 16 Good 1.00
Stock:Bond correlation -.46 Good 1.00
Total Personal Consumption Expenditures +0.2% Good 1.00
Retail Sales +4.5% Good 1.00
Gross Domestic Product -2.9% Bad 0.00
New housing starts +7.5% Good 1.00
Inflation 2.1% Good 1.00
Unemployment 6.1% Good 1.00
Average score 0.77

Of the 11 factors we track, we score 8 of them as “good” indicating positive prospects for the economy and the stock market. One is neutral and two are “bad.” On a scale of 0.0 to 1.0 our overall score is 0.77 which suggests a potentially positive outlook.

For more details on each of our metrics, see below:

Lucena’s macro economic model: 10.0/10.0 (Good)

  • Our model’s score of the economy improved from  9.2 to 10.0 out of 10.0 (Lucena Research, July 24, 2014).
  • Positive change since last report.
  • Larger numbers are better. Values greater than 0.5 represent a bullish indication.
  • Bottom line: Good

S&P 500 company earnings to price change ratio: 0.63 (Bad)

  • 12 month trailing EBIT totals are up 11.1% compared to one year ago (Lucena Research, July 24, 2014).
  • 12 month return for the S&P 500 price index (SPX) is up 17.43%.
  • EBIT delta / Price delta = 0.63
  • A value greater than 1.0 indicates that revenues are outpacing stock prices (good), while values less than 1.0 indicate prices outpacing revenues (bad).
  • Our last measure of this factor was 0.92.  The decrease since that time is further indication that prices are outpacing revenue increases.  Stock price increases are getting ahead of earnings.
  • Bottom line: Bad

S&P 500 company book to earnings ratio: +4.0% (Neutral)

  • The median book value to 12 month trailing earnings ratio is 3.02 (Lucena Research, July 24, 2014).
  • This value was 2.89 one year ago, representing an increase of about 4%.
  • Lower, or negative numbers for this change are better because they indicate that companies are generating more revenue relative to the value of their assets/resources.
  • Bottom line: Neutral

S&P 500 companies reporting losses: 3.4% (Good)

  • 16 companies in the S&P 500 report negative trailing 12 month earnings (Lucena Research, July 24, 2014).  This is a decrease by 1 since our last report.
  • This is down from 17 one month ago, and down from 40 one year ago.   The downward trend in this factor is good.
  • Lower numbers are better, but this value will eventually hit a minimum and trend up and down slightly.
  • Bottom line: Good

Stock:Bond anti-correlation: -.46 (Good)

  • 63 day trailing correlation of major stock and bond indices is -.46 (Lucena Research, July 24, 2014, RSP, TLT).
  • It is up slightly from -.58 in May.
  • Negative values for this factor indicate a normal relationship between these asset classes.
  • The current value of -.46 is a good, normal indication of an economy operating as we expect.
  • Bottom line: Good

Total Personal Consumption Expenditures: +0.2% (Good)

  • Month to month Total Personal Consumption Expenditures  (PCE) were up 0.2% in May over April (Bureau of Economic Analysis).
  • This is a modest increase, we’d like to see more, but because it is positive, we’ll count it in the plus column.
  • Bottom line: Good

Retail Sales: +4.5% (Good)

  • Retail sales were up +0.2% in April versus March and up 4.5% compared to one year ago (US Census, July 24, 2014).
  • This is an uptick since our last report.  That’s enough to push this metric from neutral to good.
  • Bottom line: Good.

Gross Domestic Product: -2.9% (Bad)

  • GDP  for the first quarter of 2014 decreased at an annual rate of 2.9% (Bureau of Economic Analysis, June 29, 2014).
  • The last quarter of 2013 was 2.6%, so this represents a substantial drop.
  • Many economists and pundits attribute the drop to bad weather, and they expect a return to higher rates. These opinions help mute the bad news, but it is still bad news.
  • Bottom line: Bad

New housing starts: +7.5% (Good)

  • Month to month new starts were down 9.3% in June vs May (US Census Bureau, July 17, 2014).
  • Up 7.5% compared to one year ago.
  • These numbers are not as strong as our last report, but still indicate positive growth.
  • Bottom line: Good

Inflation: 2.1% (Good)

  • US consumers are experiencing an inflation rate of 2.1% per year (Bureau of Labor Statistics, July, 2014).
  • This data for June is up from 2.0% since our last check.  In spite of the bump up, this is not unusual, and is still at a historic low.
  • Bottom line: Good

Unemployment: 6.1% (Good)

  • Current April rate is 6.1% down from 6.7% in March (Bureau of Labor Statistics, July, 2014)
  • Even though this number is higher than we’d like, we rate this a “good” because of the continued downward trend.
  • Bottom line: Good

Thanks to

Lucena Research quants Scott Strong and Alex Moreno wrote software to assist in this analysis.

July 24, 2014 end

May 27, 2014 Commentary

Of the 11 factors we track, two changed: Lucena’s macro economic model improved slightly, and S&P 500 earnings to price change declined slightly. We also saw improvement in the number of S&P 500 companies reporting losses (down to 17 from 20), but that was already a “good”. Taken together our factors score 7.6 out of 10 this week, indicating a positive long term outlook.

Stocks to watch:

Several of our metrics involve an assessment of all stocks in the S&P 500.  In the course of this assessment, we come across some stocks that stand out in one way or another.  Here’s a summary of those findings:

  • High price/earnings ratio: HCN. HCN has been at the top of the list two weeks running. A high P/E ratio indicates the stock may be overvalued.
  • Low price/earnings ratio: PHMDAL. PHM has been at the top of this list for two weeks running. A low P/E ratio may indicate an undervalued stock.
  • High book/earnings ratio: NWSACRM. NWSA has been at the top of this list two weeks running. A high book to earnings ratio indicates the company is not generating strong revenue compared to the value of their company assets and resources.
  • Low book/earnings ratio: WYNN. WYNN has been at the top of this list two weeks running. A low book to earnings ratio indicates the company is efficient at generating revenue.
  • High volatility: FSLRGMCR. Same ol’ same ol’.
  • Low volatility: ACE. Note that this is not Ace Hardware.

Market & Economy Scorecard:

Factor Value Impact Score
Lucena’s Macro Economic Model 9.2 Good 0.92
Total S&P 500 earnings to price change 0.92 Neutral 0.50
S&P 500 book to earnings ratio +4.0% Neutral 0.50
S&P 500 companies reporting losses 17 Good 1.00
Stock:Bond correlation -.58 Good 1.00
Total Personal Consumption Expenditures +0.9% Good 1.00
Retail Sales +0.1% Neutral 0.50
Gross Domestic Product +0.1% Bad 0.00
New housing starts +24.4% Good 1.00
Inflation 2.0% Good 1.00
Unemployment 6.3% Good 1.00
Average score 0.76

Of the 11 factors we track, we score 7 of them as “good” indicating positive prospects for the economy and the stock market. Three are “neutral” and one is “bad.” On a scale of 0.0 to 1.0 our overall score is 0.76 which suggests a potentially positive outlook.

For more details on each of our metrics, see below:

Lucena’s macro economic model: 9.2/10.0 (Good)

  • Our model’s score of the economy improved from 8.1 to 9.2 out of 10.0 (Lucena Research, May 18).
  • Positive change since last week.
  • Larger numbers are better. Values greater than 0.5 represent a bullish indication.
  • Bottom line: Good

Total S&P 500 company earnings to price change ratio: 0.92% (Neutral)

  • 12 month trailing EBIT totals are up 14.5% compared to one year ago (Lucena Research, May 27, 2014).
  • 12 month return for the S&P 500 price index (SPX) is up 15.8%.
  • EBIT delta / Price delta = 0.92
  • Larger EBIT totals are better, but increases in EBIT should be matched with increases in price.
  • Stock price increases are getting ahead of earnings, but this could be due to pricing in anticipation of a better economy going forward.
  • Bottom line: Neutral

S&P 500 company book to earnings ratio: +4.0% (Neutral)

  • The median book value to 12 month trailing earnings ratio is 3.01 (Lucena Research, May 27, 2014).
  • This value was 2.89 one year ago, representing an increase of about 4%.
  • Lower, or negative numbers for this change are better because they indicate that companies are generating more revenue relative to the value of their assets/resources.
  • Bottom line: Neutral

S&P 500 companies reporting losses: 3.4% (Good)

  • 17 companies in the S&P 500 report negative trailing 12 month earnings (Lucena Research, May 27, 2014).
  • This is down from 20 one month ago, and down from 41 one year ago.   The downward trend in this factor is good.
  • Lower numbers are better, but this value will eventually hit a minimum and trend up and down slightly.
  • Bottom line: Good

Stock:Bond anti-correlation: -.57 (Good)

  • 63 day trailing correlation of major stock and bond indices is -.58 (Lucena Research, May 27, 2014).
  • It is down slightly from -.57 one month ago.
  • Negative values for this factor indicate a normal relationship between these asset classes.
  • The current value of -.58 is a good, normal indication of an economy operating as we expect.
  • Bottom line: Good

Total Personal Consumption Expenditures: +0.9% (Good)

  • Total Personal Consumption Expenditures  (PCE) were up 0.9% in March (Bureau of Economic Analysis).
  • No new data since last week.  Next update in beginning of June.
  • Bottom line: Good

Retail Sales: +0.1% (Neutral)

  • Retail sales were up +0.1% in April versus March and up 4.0% compared to one year ago (US Census, May 13, 2014).
  • No change since last week.
  • While it is certainly good that the number was in positive territory, the value damped hopes that the  economy was accelerating more quickly (NYT).
  • Bottom line: Neutral

Gross Domestic Product: +0.1% (Bad)

  • GDP  for the first quarter of 2014 grew at an annual rate of 0.1% (Bureau of Economic Analysis).
  • No new data since last week. Next update May 29.
  • The last quarter of 2013 was 2.6%, so this represents a substantial drop.
  • Many economists and pundits attribute the drop to bad weather, and they expect a return to higher rates. These opinions help mute the bad news, but it is still bad news.
  • Bottom line: Bad

New housing starts: +24.4% (Good)

  • New starts were up 13.2% in April vs March (US Census Bureau, May 16, 2014).
  • Up 24.4% compared to one year ago.
  • This is a strong improvement and represents good news for the economy.
  • Bottom line: Good

Inflation: 2.0% (Good)

  • US consumers are experiencing an inflation rate of 2.0% per year (Bureau of Labor Statistics, May 15, 2014).
  • No change since last week.
  • This data for April is up from 1.5% for March, mostly due to increases in food costs.  In spite of the bump up, this is not unusual, and is still at a historic low.
  • Bottom line: Good

Unemployment: 6.3% (Good)

  • Current April rate is 6.3% down from 6.7% in March (Bureau of Labor Statistics, April)
  • No change since last week.
  • Even though this number is higher than we’d like, we rate this a “good” because of the downward trend.
  • Bottom line: Good

Thanks to

Lucena Research quants Scott Strong and Alex Moreno wrote software to assist in this analysis.

May 27, 2014 end

May 19, 2014 Commentary

Of the 11 factors we track, two stood out this week: New housing starts and retail sales. Taken together our factors score an 8 out of 10 this week, indicating a positive long term outlook.

New housing starts were up 13.2% in April compared to March, and up 24.4% over one year.  This is a strong sign for companies like Home Depot (HD) and Lowes (LOW), which outperformed the market after the announcement last week.   The surge in starts is focused on multifamily units such as condos and apartment buildings, which may favor REITs such as AEC and CPT. According to USA Today:

Bad weather was fingered as the main explanation for a slowdown in the housing market and the economy during the winter months. April’s housing starts report, along with better employment numbers, could be a sign that the economy will rebound in the second quarter.

Of the other factors we track, the one attracting the most attention in the last week was retail sales.  According to the New York Times:

The Commerce Department said on Tuesday that retail sales edged up 0.1 percent last month (April), held back by declines in receipts at furniture, electronic and appliance stores, as well as restaurants and bars, and online retailers.
Retail sales, which account for a third of consumer spending, rose by a revised 1.5 percent in March. That was the largest increase since March 2010 and reflected pent-up demand after a brutally cold winter.
“You really had a spectacular March,” said Guy Berger, an economist at RBS in Stamford, Conn. “You are now having an April hangover. The reality of the economy is decent but not great.”

We’d normally like to see growth in sales year over year, so this number was disappointing. However, most pundits attribute the lower number to winter weather as opposed to a general slump in the economy. We are accordingly scoring this factor as a “neutral.”

Stocks to watch:

Several of our metrics involve an assessment of all stocks in the S&P 500.  In the course of this assessment, we come across some stocks that stand out in one way or another.  Here’s a summary of those findings:

  • Increase in housing starts may favor HDLOW, and multi family REITs such as AEC and CPT.
  • High price/earnings ratio: VNOHCN. A high P/E ratio indicates the stock may be overvalued.
  • Low price/earnings ratio: PHMDAL. A low P/E ratio may indicate an undervalued stock.
  • High book/earnings ratio: NWSACRM. A high book to earnings ratio indicates the company is not generating strong revenue compared to the value of their company assets and resources.
  • Low book/earnings ratio: WYNN. A low book to earnings ratio indicates the company is efficient at generating revenue.
  • High volatility: FSLRGMCR.
  • Low volatility: ACE. Note that this is not Ace Hardware.

Market & Economy Scorecard:

Factor Value Impact Score
Lucena’s Macro Economic Model 8.1 Good 0.8
Total S&P 500 earnings +14.1% Good 1.0
S&P 500 book to earnings ratio +4.0% Neutral 0.5
S&P 500 companies reporting losses 20 Good 1.0
Stock:Bond anti-correlation -.57 Good 1.0
Total Personal Consumption Expenditures +0.9% Good 1.0
Retail Sales +0.1% Neutral 0.5
Gross Domestic Product +0.1% Bad 0.0
New housing starts +24.4% Good 1.0
Inflation 2.0% Good 1.0
Unemployment 6.3% Good 1.0
Average score 0.8

Of the 11 factors we track, we score 8 of them as “good” indicating positive prospects for the economy and the stock market. Two are “neutral” and one is “bad.” On a scale of 0.0 to 1.0 our overall score is 0.8 which suggests a potentially positive outlook.

For more details on each of our metrics, see below:

Lucena’s macro economic model: 8.1/10.0 (Good)

  • Our model’s score of the economy remains at 8.1 out of 10.0 (Lucena Research, May 18).
  • No change since last week.
  • Larger numbers are better. Values greater than 0.5 represent a bullish indication.
  • Bottom line: Good

Total S&P 500 company earnings: +14.1% (Good)

  • 12 month trailing EBIT totals are up 14.1% compared to one year ago (Lucena Research, May 18, 2014).
  • 12 month return for the S&P 500 price index is up 13.8%.
  • Larger EBIT totals are better. Increases in EBIT should be matched with increases in price.
  • Stock price increases and earnings are in balance.
  • Bottom line: Good

S&P 500 company book to earnings ratio: +4.0% (Neutral)

  • The median book value to 12 month trailing earnings ratio is 2.97 (Lucena Research, May 18, 2014).
  • This value was 2.88 one year ago, representing an increase of about 4%.
  • Lower, or negative numbers for this change are better because they indicate that companies are generating more revenue relative to the value of their assets/resources.
  • Bottom line: Neutral

S&P 500 companies reporting losses: 4.0% (Good)

  • 20 companies in the S&P 500 report negative trailing 12 month earnings (Lucena Research, May 18).
  • This is unchanged from one month ago, but down from 41 one year ago.   The downward trend in this factor is good.
  • Lower numbers are better, but this value will eventually hit a minimum and trend up and down slightly.
  • Bottom line: Good

Stock:Bond anti-correlation: -.57 (Good)

  • 63 day trailing correlation of major stock and bond indices is -.57 (Lucena Research, May 18).
  • It is up slightly from -.59 one month ago.  And up from -.66 one year ago.
  • Negative values for this factor indicate a normal relationship between these asset classes.
  • The current value of -.57 is a good, normal indication of an economy operating as we expect.
  • Bottom line: Good

Total Personal Consumption Expenditures: +0.9% (Good)

  • Total Personal Consumption Expenditures  (PCE) were up 0.9% in March (Bureau of Economic Analysis).
  • No new data since last week.  Next update in beginning of June.
  • Bottom line: Good

Retail Sales: +0.1% (Neutral)

  • Retail sales were up +0.1% in April versus March and up 4.0% compared to one year ago (US Census).
  • While it is certainly good that the number was in positive territory, the value damped hopes that the  economy was accelerating more quickly (NYT).
  • Bottom line: Neutral

Gross Domestic Product: +0.1% (Bad)

  • GDP  for the first quarter of 2014 grew at an annual rate of 0.1% (Bureau of Economic Analysis).
  • No new data since last week. Next update May 29.
  • The last quarter of 2013 was 2.6%, so this represents a substantial drop.
  • Many economists and pundits attribute the drop to bad weather, and they expect a return to higher rates. These opinions help mute the bad news, but it is still bad news.
  • Bottom line: Bad

New housing starts: +24.4% (Good)

  • New starts were up 13.2% in April vs March (US Census Bureau, May 16).
  • Up 24.4% compared to one year ago.
  • This is a strong improvement and represents good news for the economy.
  • Bottom line: Good

Inflation: 2.0% (Good)

  • US consumers are experiencing an inflation rate of 2.0% per year (Bureau of Labor Statistics, May 15).
  • This data for April is up from 1.5% for March, mostly due to increases in food costs.  In spite of the bump up, this is not unusual, and is still at a historic low.
  • Bottom line: Good

Unemployment: 6.3% (Good)

  • Current April rate is 6.3% down from 6.7% in March (Bureau of Labor Statistics, April)
  • Even though this number is higher than we’d like, we rate this a “good” because of the downward trend.
  • Bottom line: Good

Thanks to

Lucena Research quants Scott Strong and Alex Moreno wrote software to assist in this analysis.

May 19, 2014 end

May 12, 2014 Commentary

Welcome to “Market Metrics,” the first issue of a continuing series in which we report on quantitative metrics of the US economy and stock market.  Many investors look to these measures when considering whether to ease into the market or out of it.

You can think of these metrics as a kind of dashboard/scorecard for the economy and market. As of today, May 12, 2014 we have 6 positive metrics, 1 negative, and 1 mixed. This is, overall, a positive outlook.  Note that these metrics are not intended for short term market timing, but as longer term assessments (6 months to one year).

As you know, the overall market has not performed as spectacularly this year as it did in 2013.  In 2013 you couldn’t miss: Nearly all stocks went up.  I believe we’re moving into a more modest bull market in which stock picking is going to become more important.

Here’s a review of our metrics:

Lucena’s macro economic model

  • Our model’s score of the economy is 8.1 out of 10.0 (read more).
  • This is a bullish indication.
  • Bottom line: Good

Stock:Bond correlation

  • 63 day trailing correlation of major stock and bond indices is -0.43.
  • This is a good, normal indication of an economy operating as we expect.
  • Bottom line: Good

Consumer spending

  • Total Personal Consumption Expenditures  (PCE) were up 0.9% in March vs February (Bureau of Economic Analysis).
  • Consumer spending was flat March vs February and year over year (Gallup).
  • Bottom line: Mixed

Gross Domestic Product (GDP)

  • GDP  for the first quarter of 2014 grew at an annual rate of 0.1% (Bureau of Economic Analysis).
  • The last quarter of 2013 was 2.6%, so this represents a substantial drop.
  • Many economists and pundits attribute the drop to bad weather, and they expect a return to higher rates. These opinions help mute the bad news, but it is still bad news.
  • Bottom line: Bad

New housing starts

  • New starts were down 2.4% in March vs February (US Census Bureau).
  • Up 11.2% compared to one year ago.
  • Year over year rates are more important, but the short term change may affect housing and home improvement companies.
  • Bottom line: Good

Inflation

  • US consumers are experiencing an inflation rate of 1.5% per year (Bureau of Labor Statistics).
  • This rate is near historic lows, and is generally considered a good number for the economy
  • Bottom line: Good

Unemployment

Corporate profits

  • Profits are at an all time high of $1.9T per quarter as of 4th quarter 2013 (St. Louis Fed).
  • This represents a 1.9% increase over the previous quarter.
  • Bottom line: Good

Until next time

We’ll update this list with additional metrics and new data as it is reported.  Look for several additional metrics to be added next week.

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