Critical Perspectives on US Market valuations…1

These charts merely introduce the need for greater perspective when assessing valuations and valuation metrics and are not definitive. I will explore these issues in the next few posts.

People say that current market valuations are not extremely high and that relative to bond yields they are historically attractive:

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But adjust the bond yield relationship for the fact that current bond yields are very low and we see a different picture.  The following chart “what ifs” historic earnings yields to current bond yield relationships: clearly just as in the above we cannot use a current relationship to frame the past we also cannot literally use the past to frame the present, but the perspective is important.

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“What if” we were to also compare the CAPE earnings yield (that is to look at cyclically adjusted relationships when viewing the earnings/bond yield relationship) to current bond yield relationships: again we see that in the scheme of things, in an historical context that markets are not relatively attractive using this frame:

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Many people also say that the current high valuation inferred by the Shiller CAPE ignores the depression era earnings:

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Well let us adjust for depression/recession earnings, but to be strict about it let us make this adjustment consistent throughout time.  Let us base the CAPE PE on high water mark earnings (profits never fall below a previous high) and let us compare this to the actual Shiller CAPE calculation:

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Yes, we can see that the adjusted CAPE calculation is much less and pretty close to the present historical 12 month trailing P/E.  But something is odd, we see that the broad consistent message about relative valuation still shows through in the data.

We can look at these two data series another way: the relation of the current point to each historical point.   This shows that relative historical valuations are pretty similar, up the late 1950s, in terms of what the benchmark tells you about relative price of the market over time. 

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We also find that this particular adjustment makes current valuations much higher than some of those earlier in the historical dataset.  Although the analysis is meaningless because of the assumption to retain high water mark level profits, it is does have an abstract relevance.  There is a lesson here about a reliance on historically high profit levels. And this is where we move onto the next level!  

These charts merely introduce the need for greater perspective when assessing valuations and valuation metrics.  I will explore these issues in the next few posts.

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