#MarketBits: Why The S&P500 Cyclically Adjusted P/E Ratio Might Not Be Giving The Right Picture.
Updated: Jan 18
One of the most widely used valuations metrics used over the past few years has been the Shiller Ratio (or commonly known as the S&P 500 cyclically adjusted price-to-earnings ratio, or CAPE for short) which is essentially the price of stocks divided by a 10-years look on earnings to smooth out for earnings fluctuations and the business cycle instead of using the more simple current price-to-earnings ratio. And though the ratio indicates that the market is really expensive on that metric (and other metrics for that fact), there are reasons to think that the market isn’t as expensive as it appears to be.
A big overlooked element that should be considered when evaluating equities is where interest rates are which have a big impact on not only the cost of capital for companies but also the relative attractiveness of equities as an asset class compared to fixed income given where nominal yields are. At some point, when bond yields pick up equity valuations may have to re-adjust, but at this point in time with current low rates and expected easy monetary policy, equity valuations may not be as expensive as they appear to be.
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