Stock Markets Expensive, But Still In Uptrend

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Prieur du Plessis is the author of the Investment Postcards blog - subscribe here.

With the S&P 500 Index and a number of other benchmark stock market indices getting pummeled yesterday as the European debt malaise intensified, I have revisited long-term valuations and chart indicators.

The S&P 500 remains expensively valued on a long-term cyclically adjusted PE (CAPE) basis, according to Robert Shiller, economics professor at Yale and author of, among others, Animal Spirits, Subprime Solution and Irrational Exuberance.

In order not to work with notoriously unreliable forward-looking earnings estimates, I have always preferred using Shiller’s CAPE methodology, or normalised earnings, as they average ten years of earnings. This measure provides a good picture of the market’s value regardless of where we are in the business cycle. I have therefore been updating a CAPE chart for a number of years. On this basis, the multiple has increased to 26.1 since the March 2009 low of 13.3, representing a scary overvaluation of 55% when compared to a long-term average of 16.9.

sp500 normalized

sp500 log

However, CAPE would’ve kept one out of the stock market for a large part of the nascent bull market and other measures obviously also need to be considered. The chart below shows the long-term trend of the S&P 500 Index (green line) together with a simple 12-month rate of change (ROC) indicator (red line). Although monthly indicators are of little help when it comes to market timing, they do come in handy for defining the primary trend. An ROC line below zero depicts bear trends as experienced in 1990, 1994, 2000 to 2003, and in 2007. And 2011? With the ROC fairly comfortably above the zero line, the primary bullish trend remains intact.

sp large cap

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