S&P Valuation

For a back of the envelope look at valuation of equity markets, Our Man likes to check-in on the PE10 (also known as the Cyclically-Adjusted Price Earnings, or CAPE, ratio) which was made popular by Professor Robert Shiller (in his book “Irrational Exuberance).  The reasons for using a longer-term measure like the PE10 are that it helps smooth out some of the cyclical and fudge factors that occur in year-to-year earnings and that there’s lots of data so things can be considered in a historical context.

With that in mind, here is a graph of the PE10 alongside the Long-Term (10-year) Interest Rates.

From the graph, a few things seem obvious top OM:
- That 1929 and 2000 stand out clearly as peaks in PE10-terms, at 31x and 43x respectively
- That 1921 and 1981 stand out clearly as troughs in PE10-terms, at 5.5x and 6.5x respectively
- That the market at an expected 20.45x is not ‘absolutely’ cheap in PE-10terms
- That, in fact, the market isn’t even cheap ‘relative’ to the historical average
- That even in March, the market was only slightly cheap vs. the historical average
- That the last time the market was cheap for any prolonged period was in the 1980’s

So what?
What OM certainly takes from this is that there’s nothing to suggest that (US) equities are a screaming buy at this point.  However, it’s also clear that while they appear over-valued, they’ve been that way for the most of the last 20 years - talk about irrationality lasting longer than solvency, and that being S purely on valuation grounds is a fool’s errand.

Thus, with seemingly over-valued equities and a macro view that suggests a questionable outlook, Our Man remains reticent to add any equities to the book.  Though expect us to check-in with the PE-10/CAPE for an update over the course of the year.