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Key stock valuation ratio climbs above 1929 pre-crash level


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Key stock valuation ratio climbs above 1929 pre-crash level

A key stock market valuation metric has climbed above a level reached just ahead of the Wall Street crash of 1929.

The cyclically adjusted price-to-earnings, or CAPE, ratio for the S&P 500 hit 33.1 in November, above the 32.6 level it was at in September 1929, the month before the crash that preceded the Great Depression.

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"The fact that we're beyond the September 1929 levels is obviously an important milestone, and will only add to concerns that current US equity valuations have become disconnected from real economic performance," Jim Reid, a research strategist with Deutsche Bank, wrote in a note.

The CAPE ratio divides stock prices by trailing 10-year average earnings, as opposed to the standard price-to-earnings ratio, which divides stock prices by analysts' earnings forecasts.

The forward price-to-earnings ratio historically loses effectiveness at various points in the business cycle, often masking a coming crisis and then peaking toward the end of a recession. The recent rise in forward P/E was dismissed by some equity analysts due to the uncertainty of the coronavirus and its impact on forward guidance from companies.

Robert Shiller, a Nobel laureate and professor of economics at Yale University, developed the CAPE ratio as a response to the volatile and unpredictable nature of the standard forward P/E ratio.

Still, Reid wrote, CAPE is heavily skewed by mega-cap growth stocks such as Facebook Inc., Apple Inc., Inc. and Google parent Alphabet Inc., which will be key to valuations as the world eventually moves out of the pandemic.

"Can they maintain their value even as cyclicals rebound?" Reid asked.

CAPE hit its highest point in December 1999, just before the dot-com bubble burst, when it reached 44.2.