Investing

The Market that Cried Wolf

We’ve been hearing for quite some time now that US market valuation levels are quite elevated. As a matter of fact, the CAPE ratio has only been higher in 1929 and 2000, according to Robert Shiller’s publicly available data.

Comparing valuation multiples across different cycles can provide valuable context in an absolute sense but doesn’t necessarily tell the whole story.

Comparing earnings yields to interest rates, while flawed in certain ways, can provide more insight into cyclical valuation levels from one cycle to the next.

The spread between Professor Shiller’s cyclically adjusted earnings yield (1/CAPE) and the nominal 10-year US Treasury yield is higher today than it was in early-1990, early-2000 and mid-2007, potentially implying the market is not as overvalued today, relative to bonds, as it was on the eves of the three most recent recessions.

When we compare the cyclically adjusted earnings yield to the real 10-year US Treasury yield, we again find that today’s spread is higher than the three aforementioned periods although as observed in the chart below, the difference between today and the previous periods is not as pronounced. Again, a potential takeaway from this analysis is that the market is not as overvalued today, relative to bonds, as it was on the eves of the three most recent U.S. recessions.

Whether you’re a believer or a non-believer in the Fed Model, it does provide a simplistic way of comparing investment opportunity costs across cycles, which can, at a minimum, provide valuable insight. Additionally, interest rates and their related expectations do in fact drive asset valuations. It would appear today the market doesn’t think interest rates are going up enough to materially impact asset valuations any time soon. On that note, it probably makes a lot of sense to get as good of a grip as possible on where interest rates are going and how quickly they are going to get there.

4 thoughts on “The Market that Cried Wolf”

  1. I definitely wanted to post a simple message to say thanks to you for those marvelous recommendations you are sharing at this site. My considerable internet lookup has at the end of the day been paid with brilliant content to go over with my great friends. I ‘d say that we readers actually are unquestionably blessed to dwell in a magnificent community with very many lovely professionals with beneficial things. I feel very much fortunate to have encountered your site and look forward to many more excellent minutes reading here. Thanks once more for all the details.

  2. I must express my gratitude for your generosity supporting men and women that have the need for help on that area of interest. Your very own commitment to passing the message all-around came to be pretty good and has really enabled women like me to attain their dreams. Your entire warm and friendly tutorial indicates a lot a person like me and especially to my colleagues. Many thanks; from each one of us.

  3. I wish to express my passion for your kind-heartedness supporting all those that need help with the issue. Your special commitment to passing the solution up and down had become extraordinarily functional and has really encouraged workers much like me to get to their pursuits. Your personal helpful help and advice can mean a lot a person like me and still more to my mates. Many thanks; from each one of us.

  4. I and my guys ended up taking note of the good secrets and techniques found on your site then at once developed a horrible feeling I never expressed respect to the web blog owner for those strategies. Most of the boys happened to be consequently joyful to read all of them and have in effect undoubtedly been loving these things. Many thanks for getting considerably accommodating and then for choosing these kinds of great areas most people are really needing to learn about. My very own honest regret for not expressing gratitude to you earlier.

Comments are closed.