Tags: Blodget | Stocks | Fall | plunge

Blodget: Stocks May Still Fall 30 Percent Despite 512-Point Drop

Sunday, 07 Aug 2011 11:33 AM

Stocks are still 30 percent overvalued despite the recent 512-point drop in the Dow Jones Industrial Average and other meltdowns in U.S. equities markets, writes Henry Blodget, former equities analyst and CEO of Business Insider.

Fears the U.S. economy may be slowing coupled with concerns that debt issues in Europe will spread and disrupt the global financial system have investors panicking.

Yet corporate earnings have been healthy for months how, especially thanks to expansive monetary policies carried out the Federal Reserve such as quantitative easing, which have pushed stock prices very high.

"Even after the recent plunge, stocks are still about 30 percent overvalued when measured on 'normalized' earnings--which is one of the only valuation measures that works," Blodget writes.

Even after the recent crash, stocks are still trading at 21 times cyclically adjusted earnings.

"Over the past century, stocks have averaged about 16X those earnings. So we're still about 30 percent above 'normal.'"

Three former Federal Reserve officials say the U.S. Central Bank needs to roll out a third round of quantitative easing, where the Fed pumps money into the economy in order to spur stock market gains and bank lending.

In June, the Federal Reserve wrapped up a second round of quantitative easing, widely known as QE2, in which the monetary authority bought $600 billion in government bonds held by banks.

Now it's time for QE3.

"I think it's up to the central bank to do what it can to help around the edges," says Donald Kohn, a former director of the Fed's monetary affairs division now at the Brookings Institution, a Washington think tank, according to the Wall Street Journal.

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