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 graph shown below includes the most recent data (updated weekly). Draw your own conclusion as to the condition of today's market.
