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 October 4, it was 3.98%.
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:
- The extreme overvaluation and irrational period of the tech bubble
- The valuations since the start of COVID recession
- The average P/E10
- 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.
The inflation "sweet spot," the range that has supported the highest valuations, is approximately between 1.4% and 3.0%. 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 35.7 at a 2.36% year-over-year inflation rate. The inflation rate is just inside 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.
