Stocks – scant value in momentum market

By Prieur du Plessis, on March 24th, 2010 posted in: Investment, Stocks

I have discussed various yardsticks of evaluating US equities over the past few days. In short, my conclusion is that while the longer-term technical picture points to the cyclical bull market still being intact, short-term measures are exceedingly overbought and valuations look stretched whichever way you slice and dice the fundamental metrics.

Of course, bull markets can stay overbought and overvalued for a long time and it is a mug’s game to try and pre-empt tops. It’s called a “momentum market”. However, it still makes sense to understand as fully as possible what the playing field looks like. Below is a short update on another tool I have been following for a while.

The 12-month momentum of US equities, as measured by the S&P 500 Index, narrowly tracks the US GDP-weighted Purchasing Managers Index (PMI). Current levels of the S&P 500 indicate the market is expecting a GDP-weighted PMI in excess of 60 (currently 54).

If the Index maintains its current levels, the 12-month momentum will drop from 47.1% to 46.1% by the end of March and 33.6% by the end of April. Even this drop in momentum requires the GDP-weighted PMI to rise to 57 and higher. A rise from 54 to 57 is not impossible but improbable given the sub-par economic recovery.

I am therefore inclined to deduce that the US stock market is also overpriced in terms of this analysis (although not grossly so), even if the GDP-weighted PMI should improve to 57.