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Shiller P/E Ratio
Much of our commentary since the start of Bitcoin Magazine Pro has focused on the relationship between bitcoin and stocks, and their reflection of the global “tide of liquidity”. As we discussed earlier, given that bitcoin’s market size relative to US stocks is tiny (the current market capitalization of US stocks is around $41.5 trillion, compared to $452 billion for bitcoin). Given the trending market correlation between the two, it’s worth asking how over/undervalued the stocks are relative to historical values.
One of the best ways to analyze when the broader stock market is overvalued is Shiller’s price-earnings (PE) ratio. Also known as the Cyclically Adjusted PE (CAPE) ratio, the measure is based on inflation-adjusted earnings for the past 10 years. Over decades of history and cycles, it has been essential to show when prices in the market are grossly overvalued or undervalued relative to history. The median value of 16.60 over the past 140+ years shows that prices relative to earnings always find a way back. For equity investments, where the return on investment necessarily depends on future profits, the the price you pay for these winnings is of utmost importance.
We are at one of the unique moments in history when valuations have climbed just below their 1999 highs and the “everything bubble” has started to show signs of bursting. Yet, by all comparisons to previous bubbles that burst, we are only eight months down this path. Despite the rally we’ve seen over the past few months and the explosive upside move in surprise inflation that unfolded today, it’s a signal from the broader market picture that it’s hard to d ‘ignore.
Even though the release of consumer price index data came in at a startling reading of 0.0% month-over-month, year-over-year inflation is at an all-time low. unpleasant by 8.7% in the United States. Even if inflation were to come down completely for the rest of the year, 2022 would still have seen inflation above 6% during the year. The key here being that the cost of capital (Treasury yields) is adjusting to this new world, with inflation at the highest felt in 40 years, yields have risen at a record high and have lowers the stock’s multiples as a result.
If we think about the potential trajectories ahead, with inflation being fought by the Federal Reserve with tighter policy, there is potential for stagflation in terms of negative real growth, while the labor market turns around.
Looking at the relative valuation levels of US equities during previous periods of high inflation and/or sustained financial repression, it is clear that equities are still close to perfection in real terms (10-year earnings-adjusted inflation). As we believe that sustained financial repression is an absolute necessity as long as debt remains above productivity levels (US public debt/GDP > 100%), equities still look quite expensive in real terms.
Either the valuations of US equities are no longer linked to reality (unlikely), or:
- US equity markets crash in nominal terms to lower multiples from historical average/median
- U.S. stocks slump in nominal terms on sustained high inflation, but fall in real terms, undermining investors’ purchasing power
The conclusion is that global investors are likely to increasingly look for an asset to park their purchasing power that can escape both the negative real returns present in the fixed income market and the high earnings multiples (and by following weak or negative real equity returns).
In a world where bond and stock returns are lower than the annual inflation rate, where do investors put their wealth and what do they use to make their economic calculations?
Our long-term answer is simple, just check the name of our publication.