Where does the current valuation put us?
For a more precise view of how today's P/E10 relates to the past, our chart includes horizontal bands to divide the monthly valuations into quintiles — five groups, each with 20% of the total. Ratios in the top 20% suggest a highly overvalued market, the bottom 20% a highly undervalued market. What can we learn from this analysis? Over the past several months, the decline from the all-time P/E10 high dramatically accelerated toward value territory, with the ratio dropping from the 1st to the upper 4th quintile in March 2009. The price rebound since the 2009 low pushed the ratio into the 1st quintile, and it is now positioned on the lower boundary at 20.6. By this historic measure, the market is expensive.
A more cautionary observation is that every time the P/E10 has fallen from the first to the fourth quintile, it has ultimately declined to the fifth quintile and bottomed in single digits. Based on the latest 10-year earnings average, to reach a P/E10 in the high single digits would require an S&P 500 price decline below 540. Of course, a happier alternative would be for corporate earnings to make a strong and prolonged surge. When might we see the P/E10 bottom? These secular declines have ranged in length from over 19 years to as few as three. The current decline is now in its tenth year.
Or was March 2009 the beginning of a secular bull market? Perhaps, but the history of market valuations doesn't encourage optimism.
Additional Perspectives on the P/E10
In response to the occasional request I receive for a real P/E10 based on the ShadowStats Alternate CPI for the inflation adjustment, see this chart, which suggests that the current market is fairly priced. On a personal note, I find the Alternate CPI version of the P/E10 interesting, but I think it is unreliable for estimating the P/E10. Government policy, interest rates, and business decisions in general have been fundamentally driven by the official BLS inflation data, not the alternate CPI.
Yet another approach, one which avoids the question of the "correct" inflation adjustment, is to use nominal values for calculating the P/E10. The is the method of analysis favored by by Bob Bronson, a market historian whose research is occastionally featured at dshort.com. For Bronson's rationale, see this post from May 5th. Thus I'm now including a monthly update the nominal P/E10.
Copyright (c) Doug Short
For a fascinating look as several additional indicators of market valuation, see this monthly update by Jacob Wolinsky. Jacob's ValueWalk.com website in included in my list of favorites.
