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Posted on 5 August 2011 | 4,442 views

Dow Jones Stock Market Still 30% Overvalued

Whenever the stock market plunges for several days it reminds us the stock market crash in October 1929, which triggered the 12-year great depression that hit all the western industrialized nations. It all began on a “Black Thursday“, Oct. 24, 1929, when share prices on the New York Stock Exchange (NYSE) collapsed. Stock prices plummeted on that day, and continued to fall at an unprecedented rate for a full month.

Currently, all three major U.S. indices have now erased all gains made during the year. Over the past ten days, U.S. indices have fallen more than 10 percent. The 4.78 percent slide for the S&P 500 was the worst such drop since Jan. 20, 2009, when it fell 5.28 percent.

The “DJIA” just finished eight consecutive days of market losses and barely escaped the dubious 1978 record of nine consecutive days of market losses which occurred from February 9, 1978 through February 22, 1978.

It was the Index’s biggest single-day point loss since Dec. 1, 2008, when the Dow plunged 679.95 points at the height of the financial crisis.

While 497 stocks in the S&P 500 fell yesterday, declines were smaller than in the 2010 flash crash. So-called circuit breakers that halt trading when shares rise or fall 10 percent in five minutes were triggered once yesterday. The swings on May 6, 2010 were so wide that the curbs would have been set off more than 600 times had they existed, according to data compiled by Ana Avramovic, a New York-based analyst at Credit Suisse Group AG.

Is it a “buying opportunity”?

Over the short-term, who knows? If this carnage keeps up, a panicked Ben Bernanke will probably rush to announce some huge new quantitative easing program. Or Congress will quickly rethink its recent commitment to “austerity” and announce trillions of new spending and those initiatives might boost stocks for a while.

The bigger picture, however, is less encouraging. Even after the recent plunge, stocks are still about 30% overvalued when measured on “normalized” earnings — which is one of the only valuation measures that works. This puts the Dow Jones Industrial Average Index at 7,968.58 points.

Specifically, even after the crash, stocks are still trading at 21X cyclically adjusted earnings and over the past century, stocks have averaged about 16X those earnings. So we’re still about 30% above “normal” according to Professor Robert Shiller of Yale.

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