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The S&P 500’s CAPE ratio says the US is still expensive

The Fund Manager

In this article I look at the S&P 500’s response to the coronavirus pandemic, the impact on CAPE valuations and what that means for the index’s expected ten-year returns.

The world is in the grip of a rapidly expanding pandemic and countries around the world have shut down large parts of their economies and told citizens not to go outside.

The International Monetary Fund (IMF) now expect a global recession far worse than the one that followed the financial crisis and worse than any since the great depression.

Companies left, right and centre are suspending dividends and reporting revenues declines of more than 80%.

And yet despite the obvious damage being done to the global economy, the S&P 500 is not even in bear market territory.

Wot no bear market?

Okay, I lied. The S&P 500 did dip into bear market territory for a few weeks between early March and the start of April.

Having reached (yet another) record high of 3,390 in February, the US large cap index collapsed with record speed, losing more than 1,150 points (34%) in just a few weeks.

The technical definition of a bear market is a decline of 20%, so clearly the S&P 500 was in a bear market, at least for a short while.

However, over the last few weeks the market has become enthusiastic once again, with the S&P 500 gaining 28% in about three weeks.

Today (15th April) the S&P 500 sits at 2,850. That’s a mere 16% below its all-time high, which means the bear market is (for now) technically over.

So what does that mean for valuations? In other words, is the S&P 500 cheap after those double digit declines?

The short answer is no, but to understand why, we need to look at what valuations were like before the pandemic struck.

The S&P 500 went into the pandemic crash with sky high valuations

For most active investors this isn’t exactly news, but the S&P 500 has been expensive for a very long time, at least according to its long-elevated CAPE ratio (cyclically adjusted PE).

Expensive means comfortably above average, which in this case means above 17.5. That’s the S&P 500’s average CAPE ratio (the ratio of price to ten-year average inflation adjusted earnings) over the last 100 years.

When the S&P 500 was at its pre-crisis peak of 3,390, its CAPE ratio stood at 30.6. That’s a massive 75% above its hundred-year average.

To put this in context, the chart below show the S&P 500 over the last 30 or so years. The colours on the rainbow tell you whether the index was expensive, cheap or somewhere between:

Just before the pandemic the S&P 500’s CAPE was near record highs

Hopefully the colour-coding is fairly intuitive, but if not then here’s a quick guide:

Bright Red = very expensive (CAPE almost twice the average)

Yellow = normal (CAPE close to average)

Dark Green = very cheap (CAPE almost half the average)

For example:

In 1999: Thanks to the tech bubble, CAPE was literally off the charts and well above twice its long-run average. Five to ten-year returns from this point were terrible, as expected.

In 2009: CAPE was pretty cheap thanks to the financial crisis. Five to ten-year returns from this point were very good, also as expected.

In 2019: CAPE was bordering on very high at around 75% above average. Five to ten-year returns from this point were expected to be poor.

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So the S&P 500 went into this pandemic at sky high valuations, and yet so far has suffered relatively muted declines.

What does that mean for current valuations?

Believe it or not, the S&P 500 is still slightly expensive

I find this incredible.

We’re in the middle of a global pandemic which is potentially worse than any we’ve seen for a hundred years.

We’re staring down the barrel of what is very likely to be the worst global recession since the great depression of the 1930s.

Many companies are earning almost no revenues, with almost every trading update mentioning a suspended dividend, application for government loans or grants, layoffs, pay cuts, capex suspensions, rights issues and other drastic measures to increase their odds of survival.

This is not what I’d call a rosy picture. And yet in the middle of all this, the S&P 500 has rallied to the point where:

  • the S&P 500 isn’t even in a bear market anymore
  • it’s higher than it was just over a year ago, when all we had to worry about was a tit for tat trade dispute between the US and China
  • it’s still slightly expensive by historic standards

Let’s put some numbers on this.

Having started 2020 with a CAPE ratio as high as 30.6, the S&P 500’s initial 34% decline took that down to 20.2.

20.2 is lower than 30.6, but even at their most bearish, investors were still willing to place an above average valuation on US large caps.

But that was before the US government announced its $2 trillion support package.

Following the announcement of that support package, investors became even more optimistic, driving the S&P 500 up by more than 25%.

To date, this relief rally has brought the S&P 500’s CAPE ratio back up to 25.7, some 47% above its long-term average of 17.5.

It also puts the index squarely back into my “slightly expensive” CAPE range, which is the slightly orange band in the chart below:

The Fund Manager

About John Kingham

John Kingham

John Kingham is the editor of UK Value Investor, the investment newsletter for defensive value investors. With a professional background in software analysis, John's approach to high yield, low risk investing is based on the Benjamin Graham tradition of being systematic and fact-based, rather than speculative. John is also the author of The Defensive Value Investor: A Complete Step-By-Step Guide to Building a High Yield, Low Risk Share Portfolio. His website can be found at:

Articles by John Kingham

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