Stock Market Safety Index
We use the Stock Market
Safety Index (MSI) as an indicator of the market's condition. Its
main purpose is to tell us whether the market is overvalued or
undervalued. We compute the MSI by taking the difference between
an extrapolated SP500 earnings yield and the current 90-day TBILL discount
interest rate. The extrapolation is 13 weeks and computed with a constrained
quadratic least-squares fit of the preceding 52 weeks of earnings.
A MSI value greater than zero means that the equities yield is higher
than the TBILL yield and the market is undervalued. A MSI value less
than zero implies that the equities yield is lower than the TBILL yield
and the market is overvalued. In terms of return and risk, a large
positive value would favor stocks as an investment. A large negative value would
favor less risky investments, such as TBILLs. If you look at plot of
the MSI over the past it is easy to pick out the 1987 crash, the 1990
mini-crash, and the 2001 decline. In all three cases, stocks fell in
value and the MSI quickly went from a large negative number to a positive
one. Using these three events, it appears that when the MSI is less
than negative 2.0, the market is extremely overvalued and is vulnerable
to a correction. Accordingly, we ignore our market
forecast and remain in CASH when the MSI is less than negative
2.0. The MSI chart shown below includes the most recent
data (updated as necessary). Draw your own
conclusion as to the condition of today's market.
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