Market valuation backdrop revisited

• abnormalreturns
• October 8th, 2009

A few weeks ago we discussed using market valuation measures as a backdrop for making investment decisions.  At the time our general conclusion was that the market had moved from significant undervaluation to being roughly fairly valued and that the so-called easy money had been made.

Another indicator, the ratio of equity market capitalization to GDP has drawn some attention of late in part because it is thought to be Warren Buffett’s favorite market indicator.  However there does seem to be some debate on the interpretation (undervalued vs. fairly valued) of it at the moment.  We reproduce the chart below to allow for your own interpretation.

Source: GuruFocus.com

One source we mentioned in that post was the Morningstar Market Valuation Graph.  Although the market has moved up some 9% in the interim it continues to show the market trading right around fair value.  (This also highlights the fact that these measures are at best a rough guide to what the market will do in any shorter time frame.)

Source:  Morningstar.com

The whole point of this exercise is to get a better handle on the market backdrop.  There are some indications that the risk culture has returned to Wall Street.  From that perspective it seems we have entered a more normal phase for the market where risk-seeking has replaced risk-aversion.  As we have said before the market is going to do what is going to do, but the above charts indicate investors need to be a bit more discriminating than they were just a few short months ago.

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