• THE SPREAD BETWEEN US MARKET CAPITALIZATION AND BOOK VALUE IS NEAR AN ALL-TIME HIGH
• A DROP IN BOOK VALUE (TOTAL ASSETS LESS LIABILITIES) IS EXPECTED DUE TO THE ECONOMIC IMPACT OF COVID-19
• US STOCK MARKET IS OVERVALUED BY THIS MEASURE WHILE OTHER EQUITY MARKETS ARE CLOSER TO JUSTIFIABLE LEVELS
• THE US MARKET HAS FURTHER TO DROP SINCE EUROPEAN MARKETS ARE ALREADY CLOSER TO THEIR FLOORS

The valuation of the US stock market is down about 16% from its high this past February 19 when many were saying that the stock market was overvalued. The US has already recovered about half of the value lost during the COVID crash, despite a massive drop in GDP and rising unemployment. We believe that today’s stock market is overvalued in the US but that other countries’ equity markets are closer to justifiable levels.

In our recent research article we showed that unlike crashes, recoveries follow a similar pattern. Yet, the current rally does not resemble historical crash recoveries, at least from a factor perspective, which raises questions about whether a recovery has truly begun. In this piece we examine the historic market capitalizations of equities as compared to their book values in four countries: the United States, the United Kingdom, Germany and France. We used the Style Analytics database of equity fundamental measures to look at the total market capitalization and the aggregate book value (an accounting measure of the value of the assets less the liabilities) of all stocks in those countries from 1990 through April, 2020.

The US stock market is frothy

Figure 1 shows the total US market capitalization (blue line) and the aggregate book value (orange line) of US stocks. While the market cap of US equities has been, at times, significantly above the aggregate book value, the 2008 Global Financial Crisis (GFC) brought the spread to a level not seen since the early 1990’s. The market’s aggregate book value can be thought of as a kind of lower limit to the market’s value since it represents the liquidation value of the companies. As can be seen from the right-hand edge of the graph, the COVID crash did lower the spread but not by a significant amount. When you take the April rally into account, the spread between US market cap and book value is near its all-time high.

Figure 1: The Market Cap vs Aggregate Book Value for US stocks. The vertical axis is in Billions of USD. Source: Style Analytics.

There are two noticeable dips in the trend line of aggregate book value: an easily overlooked dip in 2003-2004 following the market drop of the Tech Bubble crash of 2000 and the major drop in 2008-2009 following the massive decline of the GFC. While the current economic condition hasn’t yet resulted in a drop in the aggregate book value (the numbers aren’t yet in), it’s reasonable to expect a drop in the book values of companies due to the economic shut down caused by COVID. This means that the spread between market cap and book value will be even greater if the market doesn’t experience a large correction.

European stock markets are less exuberant

The next three figures show the same data compiled for the UK, Germany and France, in billions of GBP and EUR, respectively:

Figure 2: The Market Cap vs Aggregate Book Value for UK stocks. The vertical axis is in Billions of GBP. Source: Style Analytics.

Figure 3: The Market Cap vs Aggregate Book Value for German stocks. The vertical axis is in Billions of EUR. Source: Style Analytics.

Figure 4: The Market Cap vs Aggregate Book Value for French stocks. The vertical axis is in Billions of EUR. Source: Style Analytics.

Both France and Germany have had times when their market caps equaled their aggregate book values: in the period immediately following the GFC. For both countries, the Tech Bubble crash of 2000 resulted in a market downturn that had them nearly equal. While the UK’s markets (Figure 2) didn’t dip their capitalizations as much, they certainly came quite close in both of those crashes. Since the GFC, none of the three European markets have risen so far above their aggregate book value as the American market and the COVID crash has brought them closer to that lower bound.

If any of these markets is overvalued, it’s the US stock market. The US market has proven itself capable of sustaining high valuations for lengthy periods in the past. But, when the Q2 2020 numbers come in, we believe the US market will have the most to give up since European markets are already closer to their floors.