There's not much consensus here: on the one hand, you have CAPE hitting levels typically associated with bubbles, but on the other hand, interest rates have been at never-before seen lows, which you would expect to push up the price of stocks (and other assets). So, the question is then, is the current prices of stocks justified by the low interest rate?
That is something I haven’t seen a convincing answer for. I’ve read a couple articles that related the interest rate to market prices, but the data was a bit outdated, so I decided to try to take a stab at recreating it. I looked at the historical monthly value of the 13 month Tbill (IRX), which I'm using as a proxy for the interest rate, and compared it to the historical S&P500 price and historical CAPE levels. I also ran this against the 10 year Tnote (TNX) for comparison. I think we’ve all seen the chart of the S&P500 overlaid with the falling interest rates, but it’s hard to draw any conclusions from that. Plot the interest rate against the CAPE ratio, however, and you get a pretty clear trend: http://ift.tt/2qz0C6j
Here, the Dot Com bubble stands out as clearly above the trend (overvalued), and a good portion of the time since the Great Recession stands out as being below the trend (undervalued). I took the trendline as the fair value CAPE, and from that, I backed out what the fair value for the S&P 500 was based on the current interest rates: http://ift.tt/2m8sSIj
Based on this, the Dot Com bubble and the period leading up to the Great Recession are periods where the market was overvalued, but the bull run from 2009 up until 2015/2016 was actually undervalued given the interest rates at the time. It was only recently in 2016 that the market has crossed into overvalued territory.
So, since the market is overvalued now, I should sell, right? Not so fast. Looking at it from a returns standpoint, while being undervalued is associated with a higher average return and higher occurrences of achieving a positive return, even when the market is overvalued, the average 1, 2, and 5 year returns are still positive, and the number of occasions where you achieve a positive return over those time periods almost all exceed 50%: http://ift.tt/2qBVMW0
I’m stopping here, but here is a link to the raw data if you want to play with it: http://ift.tt/2m4hsW3
Hope you find this somewhat useful.
Submitted January 06, 2018 at 12:07PM by makken http://ift.tt/2qBhXeZ
