Bloated Prices On Wall Street?

Stocks' value may soon exceed GDP

In the wake of July's sharp market downturn--and rebound--the bulls and bears on Wall Street have tussled over whether or not stock prices really are overvalued. At least one bearish analyst, James A. Bianco of Arbor Trading Group Inc. in Barrington, Ill., believes the markets have never been more overvalued than they are today. He points to some broad macroeconomic measures to bolster his case.

Bianco tracks total stock-market capitalization as a share of America's gross domestic product--a price-earnings ratio for the broader economy, if you will. By this measure, stocks are at an all-time high, at roughly 94% of GDP as of June. Previous peaks from earlier cycles: 81.4% in August, 1929, and 78.1% in December, 1972--periods that were followed by severe bear markets.

Add in the bond market's total capitalization, as measured by the Lehman Aggregate Index, and the value of financial instruments hit a record-breaking 153% of GDP at midyear 1996--well above the 57% reading in 1982, the beginning of the current bull market.

It's not just these ratios that concern Bianco. He also observes that M2--a common measure of the total amount of money in circulation--amounted to a mere 52% of the value of the stock market in June. That's one-third of the average reading this century. Concludes Bianco: "We can't have the Dow at 7000 and the long bond [yield] at 6%, because there isn't enough money to go around for both."

Some market seers think Bianco's indicators are flawed. Don R. Hays, a bullish strategist at Wheat First Butcher & Singer Inc., suspects that market capitalization has been inflated over the decades by the shift among many entrepreneurs toward operating public, rather than private, companies. But Bianco notes that research by Minneapolis' Leuthold Group shows that every time since 1926 that the stocks-to-GDP ratio crested above 70%, the median annual return averaged just 4.3% over the next five years. By contrast, when stock valuations were less than half of GDP, the market generated double-digit returns over the following five years.