Shiller's PE (Nobel Prize In Economics)
27 July 2021
One of the most frequently used metrics to determine the overall level of valuation of financial markets is Robert Shiller's PE.
Shiller in a few words: leading 20th century economist, professor at Yale University and winner of the Nobel Prize in Economics in 2013.
The logic behind the ratio he developed is relatively simple: it compares the market valuation of companies to their net income. Market capitalization is divided by the average net income over 10 years (which smoothes out the effects of cycles).
Over the long term, this ratio oscillates between 5 (postère World War II) and 45 (top of the bubble of 2000). Today, we are at 33.8 : a level highly above the one preceeding the 2008 crisis (around 27) and close to the one of 1929 - where american markets suffered a drop of -88% in 2 years. These numbers speak for themselves.
If we turn to the bond markets, the situation is not better. The risk premium offered by so-called "risky" bonds is returning to its lowest levels, which were reached twice: in 2007 before the onset of the financial crisis and in 2020 just before the outbreak of the pandemic. As a result, investors only earn an additional 2% for lending to a company that is characterized as high credit risk. This is a bet we will not take.
In this type of configuration, a purchase will offer at best a low return, at worst a capital loss. As our primary objective is to protect our assets, we are choosing prudence and are waiting.
Have a great week,
Pierre and Maximilien
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