A while back we wrote a piece describing the basic problems with Bullish opinions currently circulating about the end of the recession. In that article, we showed the various continued symptoms of our nation’s economic problems and the signs that we are still in a very real recession, even if abstract economic terminology currently suggests otherwise. Recently, I came across the following graph in an article by Henry Blodget, and I think that it shows further evidence that the stock market is already overvalued and the bulls are wrong about their predictions.
What does it show? Well, most notably it shows that stocks are currently overvalued by around 20%. Blodget here is using the cyclically adjusted P/E ratio from Robert Schiller which challenges this notion of an efficient market hypothesis (i.e. the idea that stock values are a reflection of all future earnings). Schiller’s ideas stem from the understanding that quite often stocks are bought and sold based on intuition of brokers and investors, and not on careful formulaic valuation. Ungrounded intuition, however, is not a strong investment strategy and sooner or later the market will regress back to the mean P/E ratio.