Another metric predicts the stock market quick drop

20 janv. 2020

We continue to collect signals in favor of the imminent start of a correction in the US stock market and the collapse of the bubble on it. CAPE (or Shiller's indicator), Buffett's favorite indicator, Hindenburg cancellation and Titanic syndrome, inversion of the yield curve and much more.

We have already noted that classic investment metrics (such as P/E, EPS, BVPS, etc.) have long been a signal of a strong overvaluation of the US stock market. For example, P / E is now an average of 18.4 in the market. That is, for every dollar of profit investors are willing to pay 18.4 dollars. This is a lot. Last time there were so many on the eve of the collapse of the dot-com bubble.

Today we’ll talk about another rather interesting metric. It's about the PEG ratio (Price/earnings to growth). This is an original approach to improving the classic P/E, proposed by Bank of America back in 1986. The essence of the indicator is that it eliminates the main drawback of the basic P/E indicator - delay. PEG adds a company’s growth factor to the calculation formula, which can radically change the calculation results and bring them closer to the real state of things.

According to the classics, a company whose PEG = 1 will be fairly evaluated will be. Any value above 1 indicates an overvaluation of the market.

So, according to Bank of America, the current indicator value is 1.8, which is the absolute maximum for the entire history of observations! Recall that the history of observations starts in 1986, that is, it is more than PEG on the eve of the 1987 flash crash, or the dot-com bubble, or the global financial crisis.

As you can see, this value is almost 2 times higher than normal, and also 50% higher than its average historical value. Thus, the stock market needs a correction of 40-50% in order to come to a relative norm.

Recall that we consider 2019 the last year of unjustified growth in the US stock market. Already in 2020, it will begin to adjust. The scale of correction is from 50% and higher. Considering that in recent years, shares of technology companies in the US stock market have grown on average 7-8 times (and some issuers have shown growth of 10 or even 20 times), the US stock market will no doubt become the object of massive sales. We recommend participating in this process, selling both the market as a whole (Nasdaq index) and the shares of individual issuers (Apple, Microsoft, Alphabet, Oracle, etc.).