As of market close on May 28th, with the S&P 500 Index at 1302 and the yield on the 10-year Treasury bond at 5.62%, the S&P 500 Index was overvalued by 35.1%, according to the Federal Reserve's own stock valuation model (developed for Greenspan some years ago).

The Fed uses four-quarter projected earnings, not four-quarter trailing, and currently they are relying on an extremely optimistic I/B/E/S estimate of 15.6% growth in corporate operating earnings for the S&P 500. (Consider that S&P 500 earnings actually fell 1.6% last year!) Yardeni's own earnings estimate for the S&P 500 is 3.2%. If you take his earnings estimate, plus the S&P 500 Index of 1285 and the yield on the 10-year T-bond as 5.77% (the numbers when I checked earlier today), you find that as of now the S&P 500 Index is overvalued by 61.7%. Think Yardeni's earnings estimate is too low? Well, let's take 8% as our earnings estimate--a respectable number that was bandied about by many economists and analysts earlier this year. Plugging that in with the S&P 500 Index of 1285 and the 10-year T-bond yield of 5.77%, you find the S&P 500 Index currently overvalued by 54.5%. See www.yardeni.com for an explanation of how this Fed stock valuation model was derived, plus an automatic calculator.

As I've said before, I find it very difficult to predict just how severe Y2K effects will be, in the U.S. or anywhere else. Too much conflicting or ambiguous data out there. But I do know a gigantic, potentially catastrophic stock market bubble when I see one.

Just don't tell Abby Joseph Cohen of Goldman Sachs, OK? She's still advising all her clients that the stock market is fairly valued! (Well, what business is Goldman Sachs in?) And every time the market slides a bit, she grabs a microphone. . . .

-- Don Florence (dflorence@zianet.com), June 01, 1999

Answers

Thanks, Don, interesting detail. I don't much care who gets to claim the "reason" (speculative bubble, which most of us have long bought off on) or Y2K or, IMO, BOTH. Take a popped (or popping) bubble, stir in sane 4Q "sitting on sidelines" about Y2K and WHATEVER happens 1Q 2000 and ...... ???

Betting on a 35 to 50% big-time correction sometime during this time frame is hardly a wild "doomer" idea. More like the action any cautious, sensible person would take.

ASAP.

Like today.

-- BigDog (BigDog@duffer.com), June 01, 1999.

There has been a MAJOR increase in redemptions of mutual funds recently, starting last week. It is BIG money reallocating or pulling out altogether. Analysts tend to believe the rosy analyses of firms like Goldman Sachs because it is like a huge case of corporate denial. GS wouldn't put out a bad analysis because it would be counter productive to their interests Fear of mass redemptions (kind of like the past week's)are the reason. People are starting to make their moves, whether 401k funds or directly invested. You'll have to take my word for it, the snowball's picking up speed...

-- anonymoose (not@goldmansachs.com), June 01, 1999.

It is hard to explain the current speculative bubble. Any reasonable valuation model pegs the equities market as overvalued. Corporate earnings are weak, particularly given the strong economy. Future earnings look lackluster with wage pressures, upward interest rate movements and a limited ability to expand sales.

Even without Y2K, I think the market far too fragile to sustain major shocks. Despite the Fed trying to ease the bubble, I think we'll see an ugly fall and subsequent recession.

Regards,

-- Mr. Decker (kcdecker@worldnet.att.net), June 01, 1999.

Don't forget to throw in CREATIVE BOOKKEEPING on the part of these CFO's with the blessings of their CEOs. When the chickens come home to roost many of these slight of hand techniques will be uncovered.

Ray

-- Ray (ray@totacc.com), June 01, 1999.

Periodically, there are "bubbles" which eventually burst. The great tulip bubble, the East India trading Co. bubble, 1929, 1999...

A couple of investment thoughts:

(1) Everyone can't make money the same way. If "everyone" is profiting from the same thing, then "everyone" will lose. We make money in investing by investing in scarce comodities which gain in value. Those comodities could be physical assets, or stocks in corporations which will consistently expand sales and profits.

(2) When there is a steep rise, there is ofttimes a steep decline.

(3) Look at the fundamentals. Does the investment make sense?

(4) Look at who is telling you to invest. What do they have to gain if you invest? What do they lose if you do not?

-- Mad Monk (madmonk@hawaiian.net), June 01, 1999.

No one has factored in, or really even gave credence to, a possible depression scenario. One would think that is a real possiblity. Consider the government debt as well. In a recession, earnings are, of course, considerably less. Does the government cut back? Never. Where will the money come from to create a "New Deal"? It doesn't exist. Considering the debt load of the government, and of consumers, it doesn't take an economist to paint a gloomy picture...more like a realist. It looks like depression and deflation to me. Forget inflation. that word no longer applies.....

-- rick shade (Rickoshade@aol.com), June 01, 1999.