The Investment Scientist

When the PE10 is over 29 …

Posted on: April 5, 2017

The US market ended the month of March with the PE10 at 29.02. The PE10 is a stock market measurement devised by Nobel Prize winner Robert Shiller to measure the extent of market over-valuation or under-valuation. The long-term mean of the PE10 is 17, so the current level is nearly twice the long-term mean.

There have been only two other instances in history when the PE10 was this high, one in July, 1929 and one in February, 1997. It’s very interesting to study these two instances to frame our expectations of future market returns.

In both instances, there were two or more massive market corrections in the subsequent 20 years, but the market trajectories were vastly different. See the chart here :
Screen Shot 2017-04-05 at 9.25.04 AM.png

In the 1929 instance, the market peaked two months later while in the 1997 instance, the market kept on rallying for another three and a half years before it reached its first peak. By that  time, the market had gone up 87%.

In the 1929 instance, the market bottomed out 35 months later with a total loss of nearly 75%. In the 1997 instance, the market bottomed out twelve years later with a total loss of 13%.

Here is the return table for the two instances:


Screen Shot 2017-04-05 at 9.31.09 AM.png

Apparently the 1929 instance is a bad instance. Not only did the market drop a lot, but it did not deliver much return over the subsequent 20 years; the 1997 instance is a good instance since the 20 year return was quite decent, though not outstanding. But even in the good instance, there were very rough rides and there was a 12 year period when the return was negative. Taking all together, I believe we should not abandon the market, but we do need to be a bit more defensive.

Schedule a Discovery review with me, or get my white paper for free: The Informed Investor: 5 Key Concepts for Financial Success.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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