The danger with valuations is they are a lot like a bikini – they show you a lot, they don’t show you everything.
The current Case Shiller Cyclically Adjusted PE ratio is currently 25.73. What does this mean? Since January of 1881 to today the average PE ratio is 16.61, with a standard deviation of 6.57. This means that 95% of the time the market as measured by the S&P 500 has traded with a multiple of 6.57 – 29.76.
With a multiple of 25.73 we are are certainly not a cheap market. This doesn’t mean that the market will correct tomorrow but rather that investors need to understand how current valuation effect their future return potential.
If you invest with a PE of >25, your historical, 10 year average real return is 0.5%. Not a spectacular number…
Whats an investor to do – for me its be patient. Have the valuation and return expectation favor us. Focus on investments with strong cash and well managed balance sheets – be they public or private.
Also carry some cash. Cash is the ultimate non correlated asset, it allows us to take advantage of mispricings in times of panic. In other words go shopping when assets are cheap. It means we give up potential return in the current market, but with valuations as high as they are, I’m prepared to be patient.
Thats it from me and bye for now.