Will Things Be Different This Time, Although They Have Never Been In History…Why We Have To Be Concerned
The following article highlights a number of key metrics in one chart – widely accepted valuation model and how markets are valued today; key turning points throughout history, both at tops and bottoms; defined periods of secular bull and secular bear; and the median level of valuation throughout history. This should lead to probable conclusions of where we are in the cycle today – what you should do…
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An accepted valuation model for stock markets is the Shiller PE Ratio model. It is also called the cyclically adjusted price-to-earnings ratio, commonly known as CAPE, Shiller P/E, or P/E 10 ratio, is a valuation model to equity markets. It is defined as the market price divided by the average of ten years of earnings (moving average), adjusted for inflation. Therefore short-term fluctuations do not distort the analysis. It is a look at a longer term cycle perspective.
Here is the chart and we will go through a number of elements within it:
Let’s first go through the dark blue line with is the actual Shiller PE Ratio. The following are key points to note:
- Excluding the current level, the previous six peaks (excluding 1987, as not a true peak) have averaged 29.15, lower than today’s level of 29.49
- If you exclude the irrational level of 2000, which was driven by tech craze that we will probably not see again in our lifetimes, the level is 26.15. The level is 13% higher than that today
- The four major bottoms in the market saw a CAPE level average of 6.37. The current PE10 level is 78% higher than this average
- If you look at the bottoms of each secular bear market cycle (periods where the red line is) from 1900 to current, the average PE10 or CAPE level is 5.66. The current PE10 level is 81% higher than this
- The current PE10 level is the third highest in history and catching up on the September 1929 level
- The median line for PE10 (orange line) has averaged 16.12 from 1880 to current. The market is currently 45% above the median
Clearly, we are in a very overvalued market today, which can primarily be explained by Central Bank support for the past eight years; historically low-interest rates; and very high confidence.
So let’s look at some other components of the chart above:
- At the bottom of the chart are the secular cycles (long term cycles including bull cycles – very positive and bear cycles -volatile and negative)
- Since 1900, we have been in a period of secular bull for 51 years or 44% of the time. These are periods where you want to be invested and find the best growth companies. Buy and hold works.
- Since 1990, we have been in a period of a secular bear for 66 years or 56% of the time. This doe not mean you should be invested during this period, but you have to have a timing mechanism to be out during the crashes
- During these secular bear markets (4 of them since 1900) there were 19 cyclical bear markets where markets corrected 20% or more. Of those 19, 11 were greater than 40%. These are periods of major volatility and crashes. Buy and hold fails
- Therefore, during the four secular bear periods (we are still in the last of these) markets have crashed an average of 4.75 per cycle.
The market is clearly overvalued, but it can become more overvalued. We have not seen clear signs that we are in a bubble stage as of yet. We are looking for a decent correction at this time followed by a major rally to new highs. It is our anticipation that this new high will be attached to record levels of optimism and even long term bears throwing in the towel and saying stocks will keep going up.
The day of reckoning is coming. It could be starting now, although as we stated, we expect a Wave 4 correction, as per Elliott Wave, followed by one last surge of confidence in the final Wave 5 before a significant or possibly major crash.
Secular bear markets end once PE levels become extremely low. As you can see, previous secular bear market lows have hit 5 to 7 range. Even if stocks reached a low of PE10 low, that would still cause a minimum 66% correction. We say minimum as, during periods like this, earnings tend to contract. We base the correction on current earnings, so if they collapse, the market should collapse even further.
You need to have objective, proven tools as to when to exit stocks, and for prudent investors when to make money on the short side of the market, as markets collapse. We provide these tools and advise our customers where when we recommend exiting the market.
Stock market investing is not a pure science, but it does provide major probabilities for those who understand how they work. If a probability does not occur, you adjust your approach and do not let emotions get in the way. Sign up for our FREE Fortrus 4-Minute Analysis. We will be looking at many other indicators that are telling to all our wealth.
Founder & Chief Investment Strategist
Fortrus Investment Coaching