U.S. stock market overvalued, headed for drop-News Analysis

U.S. stock market overvalued, headed for drop-News Analysis

Despite a flagging economy and growing indications of a weak recovery, U.S. stocks continue to climb at a steady clip. But analysts said the market is overvalued and headed for a drop, Xinhua reported.

Meredith Whitney, Chief Executive Officer of the Meredith Whitney advisory group, expressed pessimism about the market in an interview this week on CNBC, a cable TV network.

"I haven't been this bearish in a year," she said. "I look at the board and every single stock from Tiffany to Bank of America to Caterpillar is up. But there is no fundamental rooting as to why these names are up, particularly in the consumer space."

While the economy grew last quarter at a seasonally adjusted 3. 5 percent from the previous quarter, many consumers are still feeling the sting of unemployment, which hit double digits in October for the first time since April 1983 and is expected to rise further. The underemployment rate -- a measure of part time workers who would prefer full-time work and people who have given up seeking work -- stood at 17.5 percent in October.

The housing market is still faring poorly and millions of homes are headed for foreclosure over the next few years, analysts said.

Also troubling is that the economy may be headed for a double dip recession in 2010, although it may not be as severe as last year's economic nose dive, Whitney said.

Those factors could bode ill for the market and many stocks are likely to return to "tangible book value," although they may avoid plunging to March levels, when the Dow Jones industrial average fell to lows not seen since 1997, she said.
Douglas Elliott, fellow at the Washington, D.C.-based Brookings Institution, tags the overvaluation at around 20 percent.

The market's recent rise can be traced back to March, when stocks tumbled due to a number of factors including concerns over the financial sector and the global economy.

But once it became clear that the downturn would stop short of becoming the next Great Depression, the market bounced back in one of the strongest rallies in years.

Now it is in for another slide, once it catches up to all the negative indexes that indicate the economy will slog toward a recovery at a sluggish clip instead of bouncing right back to pre- recession levels, he said.

"So you are going to be looking at an unexciting (market) environment and one that is a bit scary," he said.

Still it is difficult to forecast when the drop will occur -- even financial advisors are often wrong, Elliott said.

Desmond Lachman, resident fellow at the Washington, D.C.-based American Enterprise Institute, said: "The market looks like it is somewhat divorced from the fundamentals."

"It thinks we are going to have a 'v shaped' recovery," referring to a rebound that returns to pre-recession levels -- a prediction that is unlikely to pan out, he said.
But it is unclear how long the current overvaluation will last.
"When you get a movement that's divorced from fundamentals it could go on for a while," he said. "But at some point the market will correct once it sees (economic indicators) come out on the disappointing side."

"Whether it's three months or six months is hard to know but you are talking about that kind of time frame," he said.

But whenever it occurs, it is unclear how significant an impact a 20-percent drop will have.

Elliott said: "It will have some effect on confidence but that' s not a big enough move to have a huge impact."

Besides bouncing back from record lows, Lachman said another factor driving the market is low interest rates. "People are taking on a lot of risk because interest rates are low and the Fed is pumping huge amounts of liquidity into the system," he said.

Elliott said borrowing for certain types of investments -- such as a liquid financial investment as collateral on a loan -- has also pushed up the market.

The market has also escaped many of the woes that have befallen small companies, which have suffered tremendously under the recession and are having difficulty obtaining much-needed credit, he said. But that is a non-issue for most large businesses listed in the stock exchange.

So with the market headed for a drop, where should the average investor park his or her money?

Elliott said now is not the time to play the market and expect large short-term returns. Key is diversification and long term planning, he said.

"There's no reason to think the average investor should have a great idea of where the market is going," he said.

Some experts said sitting on cash is not a bad idea, as it is difficult to map out a precise course for the market.

Lachman said: "To chase this market when it is running up, one is just exposing one's self to risk."

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