Monday Morning: Is it too soon to jump back into stocks?

Deposits at commercial banks increased by 11% in September, compared with a 10% increase in September 2000 and 4% in September 1999. Much of the money flowing into bank accounts apparently is coming from stocks or equity mutual funds.

At first glance, the change would suggest that investors are giving up on the stock market, or are at least balancing their investments more.

But the data also show that much of the money now flowing into banks is going into low-interest demand deposits rather than into higher-interest certificates of deposit.

That in turn suggests that investors are staying liquid so they can reallocate back into the stock market when it shows signs of recovering, or at least when the economy shows signs of recovering.

That may be good for the market, but will it be good for investors? They may be lured into recommitting to the market too soon, and they may get whipsawed. Several analysts have published papers suggesting that all the air is by no means out of the market bubble.

The first such study to cross my desk was by Clifford Asness, managing principal of AQR Capital Management LLC in New York, which examined the market’s current price-earnings ratio, compared with the historical average, using three separate ways of calculating the p/e.

First, he examined the p/e of the Standard & Poor’s 500 stock index using normal trailing earnings. Using that measure, he found that the ratio, while down to about 27 at the end of September, from more than 35 in March 2000, still was in the 98th percentile of all observations since 1881.

Even since 1950, the p/e was in the 95th percentile. In addition, the average p/e at the end of September was still higher than at any time in the past (other than 1998-2000), including the peak before the 1929 market crash.

Mr. Asness next looked at the p/e using not last year’s earnings, but an average of earnings over the past 10 years. The ratio of the S&P 500 reached a peak of 45 in March 2000 and then dropped back to below the peak of 1929. Still, as of September 30, the ratio was in the 91st percentile of observations since 1950.

Finally, Mr. Asness examined the earnings for the best three-year period in the past 10 years.

Using that level of earnings, he found that the ratio had peaked at 35 times and now was approximately the same as the 1929 peak. That put it in the 88th percentile since 1950 and the 95th percentile since 1881.

Paul Kasriel, director of economic research at Northern Trust Corp. in Chicago, looked at two different measures of value. Theoretically, he says, the value of a stock today is the discounted value of the company’s future earnings. The problem is in knowing the future earnings.

Mr. Kasriel assumed, conservatively, that future earnings would be the same as today’s, and then he used that earnings estimate to calculate a theoretical total stock market capitalization.

He compared that theoretical capitalization with the actual market capitalization (the actual value of all the outstanding shares) from as far back as 1953.

He found that the actual market capitalization was significantly lower than the theoretical market capitalization until 1998.

Since then, the actual capitalization has exceeded the theoretical capitalization. The excess of actual over theoretical capitalization reached its peak in the first quarter of 2000. The excess had declined but still existed at the end of this year’s second quarter.

Mr. Kasriel also compared the book-value net worth of all non-financial companies with the market capitalization. Dividing the market capitalization by the book-value net worth, he found that the result reached a peak of 183 in the first quarter of 2000. That is, the market capitalization exceeded the book-value net worth by 83%.

The figure, known as Tobin’s Q, named after Nobel Prize-winning economist James Tobin who developed the concept, was never above 100 before 1995 and was only 33 in the last quarter of 1974.

Anything over 100 would suggest an overvalued market to Mr. Kasriel.

As of the second quarter of this year, it was 129. The market swoon in September probably took it lower, while the resurgence in October lifted it again, so it’s probably still close to 129.

So if your clients start urging you to increase their equity exposure, or ask you what they should do, simply point out the above facts to them. By those measures, the market still is significantly overvalued.

As for me, I’m reconsidering my recent increase in equity exposure. Maybe I was too hasty.

Mike Clowes is editorial director of InvestmentNews.