We just got new PMI numbers for the U.S. and it isn’t pretty. We dropped from 54 to 51. That also means that GDP will likely not grow. And that also means that the U.S. stock market is in for a correction.
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| Chart 1: PMI Vs. GDP |
Because the Warren Buffett rule is, the stock market can’t go much higher than the GNP. GNP is at 16.1 trillion, the total stock market index is at 16.3 trillion. This means: overvalued.
I say get out of U.S. stocks.
There are several indicators today, marking a major top in the stock market. One of those indicators is the overvaluation in the stock market according to the “Warren Buffett Valuation” of the total U.S. stock market index as compared to U.S. GNP. We found out that stock markets are overvalued today, because the total U.S. stock market index is at 100% of U.S. GNP. Normally we see that the total U.S. stock market index is at 80% of GNP. We just recently had news that U.S. GDP was negative and I wrote about it here. When GDP declines, it inherently means that the stock market must decline, taking into account the Warren Buffett Valuation theory.
Investors are much too bullish on stocks at this moment and we can see that in the Dow-Gold ratio, which is hitting a ratio of 9 to 1 as we speak.
I believe though, we shouldn’t be so complacent about stocks. After all, the P/E ratio of the Dow Industrials stands at 15.3 right now, while in the 70’s, the P/E ratio was on average at 10, which is much lower than 15.3. The question is: “Do we expect higher or lower earnings in the future?”. I believe the earnings are going to get worse in the future. One way to measure this is to look at the Citigroup Economic Surprise Index (CESI). This index is defined as weighted historical standard deviations of data “surprises”. In human language it means that if the index turns negative, the chance of an “unexpected” downward revision goes up. You will hear more bad news out of the media. And what do you know, the CESI did turn negative in the previous month. So you can expect more bad news coming. Historically, when the CESI goes down, the stock market goes down a few months later as you can see on chart 1.
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| Chart 1: Citigroup Surprise Index Vs. S&P |
To read more evidence on a top in equities, go here.
Correlation Economics (Backup) 