Market History 1928 to Present
This market history chart, 1928 to present, shows the S&P 500 equity index annotated with valuation ratios (Shiller's Cyclically Adjusted Price Earnings [CAPE] Ratio also referred to as PE 10, total Market Capitalization/GDP also referred to as "Buffett Ratio", and Tobin's Q-Ratio which is a measure of replacement cost); S&P 500 Dividend Yield; 10 year Treasury Note Yield; and the Consumer Price Index. This gives us a clear picture of market conditions across nearly a century of market history. The green legend is assigned to major equity market tops, red is assigned to major equity market bottoms, and blue is assigned to equity market breakouts from major bases.
Current market valuations are among the highest levels recorded. Three years ago, when the 10 Year Treasury yield was 1.37% and the CPI inflation rate was 0.8%; many market analysts offered the hypothesis that the, then, modestly high valuations (MC/GDP at 120%+-) were supported by the ultra low interest and inflation rates. With the 10 Year yield now hovering around 2.5% and the latest CPI hovering around 2%, it would appear that the legs have been kicked out from under the interest rate/inflation hypothesis yet MC/GDP is now approaching 150%. So where does that leave us?
Since 1900, the equity market has had an inflation-adjusted annualized return rate of 6.66%, yet the price investors have been willing to pay for equities has ranged from CAPE as low as 5 times earnings to as high as 42 times earnings with an average of 17 (currently 30+). On a trailing twelve month basis, the valuations have ranged from a PE of 5 times earnings to 124 times earnings with an average of 16 (currently 22). The sheer width in the range of valuations clearly indicates that a major factor, other than earnings, is at work in valuation.
Investors who look to classical economic fundamentals for the answer are looking in the wrong place, It is behavioral economics which better explains shifts in investor psychology which cycles from excessive pessimism (Fear) to excessive optimism (Greed). We can expect extreme valuations to remain high and even move higher until investor psychology begins its inevitable shift from extreme Greed toward Fear.
This Market History Chart is generally updated each weekend. Data is sourced from St Louis Fed (FRED), MultPl, BLS, and Advisor Perspectives. Advisor Perspectives publishes a series of four very useful valuation measures which are updated monthly.
Valuation measures have no application to short term market timing; however they are useful in alerting us to prospects for future risk adjusted return. The ideal world for long term investors is one where prospective returns are relatively high and prospective risks are relatively low. I developed the Market Conditions Model for exactly this purpose ... to select the fund basket which is most suitable for current market conditions across each stage of a Full Market Cycle.
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