Eric Mansson
๐— ๐—ฎ๐—ฟ๐—ธ๐—ฒ๐˜ ๐—ฉ๐—ฎ๐—น๐˜‚๐—ฎ๐˜๐—ถ๐—ผ๐—ป๐˜€ ๐—ฅ๐—ฒ๐—ฎ๐—ฐ๐—ต๐—ถ๐—ป๐—ด ๐—ก๐—ฒ๐˜„ ๐—›๐—ฒ๐—ถ๐—ด๐—ต๐˜๐˜€ Time to sell, or hang tight? The recovery in the broad U.S. index S&P 500 has been quite massive since tariff worries peaked this spring. From the bottom on April 8 up until last Fridayโ€™s close, the index has climbed almost 34%. Earnings expectations have also risen as the risk of recession has eased, but not nearly as much as the stock market itself. As a result, valuations have moved higher. Measured as the forward P/E ratio (price/earnings for the next 12 months), valuations now stand just below 23 โ€” clearly above the 5-year average of ~20 and the 10-year average of ~18.5, according to FactSet. Another long-term way of taking the marketโ€™s temperature is the Shiller P/E ratio, or CAPE (cyclically adjusted price/earnings), developed in the 1980s by Yale professor Robert Shiller, who later received the Nobel Prize in 2013 for his empirical studies of asset prices. Unlike the traditional P/E, which looks at near-term earnings forecasts, CAPE uses average, inflation-adjusted earnings from the past 10 years. This smooths out business cycle effects and one-off events. Since Shillerโ€™s model includes data all the way back to 1871, it allows long-term comparisons. The news now is that in September, CAPE has passed its previous peak from late 2021. Based on last Fridayโ€™s close, it stands at 39.5. The highest level ever recorded was just under 45 in December 1999 โ€” only months before the dot-com bubble burst. The previous sharp peak, in 1929, came just before the Great Depression. This history has given CAPE a reputation for flashing eerily accurate warnings ahead of major downturns. At the same time, there are reasons why todayโ€™s high multiples may be more justified: โ€ข The index composition is different, with a high concentration of profitable global tech companies with strong growth, cash flows, and lower capital needs. โ€ข Long-term interest rates have trended lower for decades (despite the recent reversal), supporting higher P/E levels (didnโ€™t have data prior to 1954 in the picture below, sorry!). โ€ข Also, valuations can also remain elevated for a very long time without the market taking a hit. My takeaway is that the new record CAPE level should not automatically be seen as a signal of an imminent crash. But itโ€™s a good reason to review exposures and risk, since sooner or later the market will move back toward more average valuation levels and given that it is getting quite far off, the possible height it can fall from is getting bigger. As for whether itโ€™s going to be โ€œsoonerโ€ or โ€œlaterโ€ โ€” not even a Nobel Prize-winning economist can answer that. If you found this update useful, please make sure to hit the like button to show your appreciation. And if youโ€™re ready to get your exposures and risk in control, the copy button is just a click away! $SPX500 $NSDQ100
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