(Updates to include Mobius comments in sixth paragraph.)

Aug. 22 (Bloomberg) -- U.S. stocks are set for a "significant rally" which will provide an opportunity for investors to sell before equities resume declines, according to economist Andrew Smithers.

Companies are cashed up and likely to buy back shares at a time when price-to-earnings ratios are low, providing a trigger for a short-term rally, said Smithers, who claimed stocks were overvalued in 2000 before a near 50 percent decline over 2 1/2 years. Investors should sell shares once their holdings gain 10 percent because even after the recent rout, U.S. stocks are about 40 percent above fair value, the president of research company Smithers & Co. said in an e-mail on Aug. 18.

"There is a good chance of a rally because of the cash position of U.S. companies, their tendency to buy shares when they have high cash ratios and the importance of company share buying on the stock market," Smithers said. "A 10 percent rally would be an opportunity to sell."

About $8.2 trillion was wiped off the value of global equity markets from July 22 through Aug. 19 as Europe's debt crisis deepened and investors speculated the U.S. economy may contract. Standard & Poor's 500 Index companies have about $291 in cash and short-term investments per share, according to data compiled by Bloomberg. That's the highest since 1998, when Bloomberg data became available.

Futures on the S&P 500 Index expiring in September gained 1.1 percent at 7:11 a.m. in New York today, after falling as much as 1 percent as German Chancellor Angela Merkel said she would resist a common euro-area bond to fight the debt crisis.

Mobius Sees Rally

Recent declines mean stocks are now "bouncing along the bottom" and are poised for a rally, Mark Mobius, executive chairman of Templeton Asset Management's emerging markets group, said in a telephone interview with Bloomberg Television today. The firm is buying shares of commodity producers, expecting materials prices to rise as the U.S. Federal Reserve keeps interest rates near record lows and buys more Treasuries.

"At this point, I do think we're bouncing along the bottom," Mobius, who helps manage about $50 billion, said. "For us in equities, it's particularly good because people will eventually realize that to beat inflation that's coming as a result of this higher money supply, we're going to have to be into equities."

Smithers said in a report dated Aug. 15 that the S&P 500 is still overvalued by about 43 percent relative to earnings for the past 10 years, a time frame endorsed by Yale University's Robert J. Shiller. Relative to the Q ratio, a comparison of market value with the replacement cost of assets, the index is about 36 percent too high, he said.

'Hold Cash'

"Investors should not, in general, buy stocks at this level, as the stock market is likely to become cheap at some time during the next 10 years and there is therefore a high risk that anyone buying today will lose money before they start to get a positive return," Smithers said. "In these circumstances, they are likely to be better off by holding cash until the market has fallen."

Smithers uses Equity Q, a variant of a ratio made famous by Nobel Laureate James Tobin, as an indicator of whether the market is overvaluing or undervaluing company assets. He uses estimates of market value published by the Federal Reserve.

Investors are "foolish" to use price ratios based on current earnings as a yardstick of whether the market is attractive, Smithers argues. The S&P 500 lost 16 percent from this year's high on April 29 through Aug. 19 and trades at 12.3 times trailing earnings, close to the level in March 2009, when stocks bottomed after Lehman Brothers Holdings Inc. collapsed. The average of since 1954 is 16.4 times, according to data compiled by Bloomberg.

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