Are US equities already cheap again after the price losses of the last few months? Should stocks be bought again now to benefit from a broad recovery move? Or should one still be cautious and expect further bearish moves? Many investors are now asking themselves these questions.
In assessing how “cheap” or “expensive” the US stock market is from a fundamental perspective, the so-called Shiller P / E has proved its worth. Like regular P / E, Shiller’s P / E ratio compares price (in this case, the price of the broad US large-cap S&P 500 index) to corporate earnings. In contrast to the normal P / E ratio, however, the Shiller P / E ratio uses the inflation-adjusted average profit over the past decade.
In boom phases, not only prices, but also corporate profits usually soar to unimaginable levels, only to plunge back into the next crisis. Using average earnings over the past decade, Shiller’s P / E offsets fluctuations in corporate earnings levels caused by the business cycle.
A look at the history of Shiller’s P / E ratio shows how the recent price drop has already reduced the valuation of the S&P 500. Compared to the long-term average, however, Shiller’s P / E ratio is still at a very high level.
The recent price drop has already reduced Shiller’s P / E from 39 to around 30. (Based on Thursday night’s closing price.) However, the valuation is still at a level that has only been reached in three periods in the past. 140 years, particularly in the run-up to the Great Depression of 1929, on the Internet bubble at the turn of the millennium and over the past five years.
If the valuation even returns to the long-term average level (Shiller P / E of around 17.3), the S&P 500 should drop to around 2264 points, which would be less than around 42%.
If the S&P 500 were to return to all-time lows of the past 140 years, even significantly greater price losses should be planned:
- After the Internet bubble burst, Shiller’s P / E fell to 13.3. This would currently correspond to a price level of around 1,740 points in the S&P 500 and less than around 56%.
- In the early 1980s, during the last phase of hyperinflation, Shiller’s P / E ratio plummeted to 6.7. That would equate to an S&P 500 level of just 877 points today. To reach this level, the index would have to drop by around 78%.
- At the beginning of the 1920s the Shiller P / E even reached a value of 4.8. The S&P 500 is expected to fall by around 84% to 628 points to regain this level of valuation.
|Comparison level for Shiller P / E||Shiller-KGV||Course in the S&P 500||modify|
|long-term average||17.3||2,264 points||– 42%|
|after the Internet bubble burst||13.3||1,740 points||– 56%|
|High inflation phase in the early 1980s||6.7||877 points||– 78%|
|Early 1920s||4.8||628 points||– 84%|
There is, of course, no evidence that the US stock market is actually heading towards the levels of the last few decades in terms of valuations. However, a look at the Shiller S / S shows that given the previous price losses, it is by no means a given that it cannot drop much below. In terms of valuation, there is still a lot of room for maneuver on the underside. In extreme cases, the price losses recorded so far in the S&P 500 could be just the beginning of a much broader downward movement.
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