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Looking at the Evidence - March 2019

April 2th 2019 – Written by Andrew Chorley

Looking at the Evidence

We have written on many occasions highlighting the risks of current Stock Market valuations, particularly in the US. It still seems to us though that many investors are ignoring the evidence.

The case for a continuation of a rising stock market seems to be founded on ultra-low interest rates and Central Bank willingness to undertake Quantitative Easing programmes that in recent years have supported equity prices.

Whilst interest rates are low the yield on some stocks looks very attractive; after all, even at the current modest inflation levels the real value of cash at the bank is being eroded.

We use the US given its importance and links to other markets and the availability of data back over fifty years or more. The indicators here are not exhaustive but are some of the key ones that we look at in making investment decisions.

Valuation Levels

Stock markets valuation levels are typically assessed by price ratios; the most watched is the Price Earnings or PE ratio that divides the share price by the earnings per share (EPS). The EPS is effectively the profit for each individual share.

High levels suggest investors are bidding up stock prices in the belief that earnings will continue to grow at current or better rates in the future.

In the chart to the right, we see that the US PE ratio peaked in 1999/2000 (Tech Bubble) before hitting the lows of the Financial Crisis. Late 2018 we also saw a warning sign as the ratio was in the 80th Percentile (top 20%) of readings at almost 25x earnings.

Further analysis is provided in Looking at the Evidence - March 2019 in our Investor Education section. 


EST. 1999