Currency Wars: “Beggar Thy Neighbor” Policy
February 12, 2025
It is common knowledge that sports leagues all over the world rake in billions of dollars when it comes to annual revenue. It is also known that all these leagues have a well-developed fan base. Famous leagues such as the English Premier League, the NBA, etc have various sports franchises which are very competitive. They […]
As we have already seen in previous articles, corporations all over the world have started automating their payments. Unfortunately, a high degree of automation has also given rise to a high degree of financial fraud. This has created an opportunity for a commercial bank to provide a service to their corporate customers. This is where […]
Any stock market around the world is huge in size. It is made up of many participants who regularly buy and sell assets. Since there are so many buyers and sellers, and the money is spread out amongst them, none of them has complete control over the events that take place in the market. The […]
Businesses may all look the same when you look at the building in which they operate, the employees they hire and the product they sell. However, they can be very different when it comes to their legal structure. The legal structure determines the type of entity they are which in turn determines the rules that […]
In the previous articles, we have already studied the difference between defined benefit plans and defined contribution plans. We now know that defined-benefit plans promise to pay the retiree a fixed nominal amount whereas defined contribution plans promise to pay the retirees the worth of their investment portfolios. There is a big difference between the […]
All stock market investors know that markets go through periods of euphoria and panic. During periods of euphoria, investors keep on buying shares in the hope of a higher payoff. In technical terms, this is the situation wherein the entire market becomes overvalued. The opposite of this also happens when fear grips the market, everybody starts selling all their shares and the market becomes undervalued.
The problem is that overvalued and undervalued markets are normally seen in hindsight. Most investors believe that the market that they are in at the present moment is fairly valued. If the market is overvalued, experts often come up with theories that suggest why this time it is different and why overvalued markets are going to be the new norm. Hence, if an investor is genuinely able to ascertain whether or not a particular market is overvalued, they have a definite edge over the others in the marketplace.
In this article, we will have a closer look at some of the factors that help investors identify overvalued markets.
An overvalued market can be identified by making comparisons with the right frame of reference.
A weighted average of the price earnings ratio of the companies that make up the index is used to calculate the price-earnings index of the entire market.
Generally, the price-earnings index stays around the mean. This means that if you calculate the price earnings ratio based on historical data, the average is the normal Price Earnings ratio.
Hence, if the present P/E is much greater than the historical average, then the market is overvalued. This is exactly what happened in the case of the Great Depression, the dot com bubble as well as the Great Recession of 2008.
If this ratio falls below 0.7 or so, it could mean that the market is undervalued and could provide a buying opportunity.
On the other hand, if this ratio crosses above 1.25, the market is said to be overvalued.
The problem is that the numbers required to calculate this ratio are not available to the general public. However, there is a workaround. Neutral organizations like the World Bank keep on publishing this data every quarter. This number does not really change too much every day. Hence, a quarterly frequency is good enough.
To sum it up, the two metrics mentioned above do provide a mechanism to identify overvalued and undervalued markets. However, it needs to be understood that the recommendations cannot really be blindly followed. This is because there may be other factors involved too. Hence a thorough understanding of such factors is necessary before making any investment decisions.
Your email address will not be published. Required fields are marked *