Market Valuation, Inflation and Treasury Yields

Our monthly market valuation updates have long had the same conclusion: US stock indexes are significantly overvalued, which suggests cautious expectations for investment returns. On August 4, 2020, the 10-year Treasury yield hit its all-time low of 0.52%. As of November 30, it was 4.37%.

P/E10 and Inflation

Here is a scatter graph with the market valuation on the vertical axis (log scale) and inflation on the horizontal axis. It includes some key highlights:

  1. The extreme overvaluation and irrational period of the tech bubble
  2. The valuations since the start of COVID recession
  3. The average P/E10
  4. Where we are today

The inflation figure in the highlighted box is year-over-year. I have also highlighted the inflation "sweet spot" in purple, which I discuss below. Note on inflation: The inflation figure is extrapolated for last month is based on the previous two months.

P/E10 and Inflation Scatter since 1881

The inflation "sweet spot", the range that has supported the highest valuations, is approximately between 1.4% and 3%. We highlighted the extreme valuations associated with the tech bubble, which we chose arbitrarily as a P/E10 of 25 and higher.

The latest P/E10 valuation is 29.9 at a 3.31% year-over-year inflation rate. The inflation rate is just outside the sweet spot and the current P/E10 valuation is in the extreme valuation territory mentioned above. Again, a note on inflation: the inflation figure is extrapolated based on the previous two months. The Census Bureau's CPI figure for the previous month does not come out until mid-month. These extrapolated figures are then updated to the current Census Bureau number when released.