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Lombardi Letter: Extreme Valuations Say a Stock Market Crash Is Nearing

November 19, 2020
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Article by Moe Zulfiqar in Lombardi Letter

Key Valuation Measures Say Stock Market Crash Could Be Around Corner

Another stock market crash could be right around the corner. Don’t get complacent. If you thought the crash in March was bad, the next one could be worse.

Right now, the stock market is roaring. Key stock indices are at all-time highs and investor sentiment is bullish. Each day, there’s some firm coming out with higher targets for the indices, and investors are buying shares in the hopes they’ll make money.

But have you looked at valuations lately? They’re in danger territory.

Look at the stock market to gross domestic product (GDP) ratio. It essentially tells us how expensive or cheap the stock market is relative to GDP. This is one of Warren Buffett’s favorite indicators.

Currently, the stock market to GDP ratio stands at 176%!

What does this 176% figure really mean? When this ratio is below 73%, it’s a sign that the overall stock market is significantly undervalued. When the ratio is between 93% and 114%, it means the stock market is trading at fair value. Anything above 135% means the market is extremely overvalued relative to the economy.

At 176%, the stock market to GDP ratio says the market is well beyond overvalued. One could even say the market could be entering a euphoric state.

Here’s the thing: don’t just take that one valuation measure and run with it. Other valuation measures of the stock market suggest the exact same thing, that the stock market is overvalued and that things may not end well. A stock market crash could become a possibility.

Currently, the CAPE ratio stands at 31.6.

The historical-average CAPE ratio is around 17. At its current level, the ratio suggests that the stock market is overvalued by about 86%.

The higher the valuations, the more careful investors need to become. Keep this in mind: while valuations don’t tell us when the stock market crash could be, they do indicate that the odds of it happening are ....

To read this article in Lombardi Letter in its entirety, click here.

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