In a recent article “Earnings-Price Divergence Always Followed by Negative Returns,” I noted that every extreme divergence (-20% or lower) between year-over-year corporate profits and equity prices in the past 50 plus years was followed by negative year-over-year equity returns. Unfortunately, the earnings-price divergence dropped to -21.3% during the quarter ended 9/30/2012. While the relationship between extreme earnings-price divergences and negative year-over-year equity returns is compelling, the elevated price-to-sales ratio for the S&P 500 index provides even greater evidence the market is currently overvalued.
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