Thursday, July 9, 2015

7/9/2015 Note to Chicken Little

A quick update for the “sky is falling” folks.

You’ll see a lot of noise out there about the CAPE ratio being higher than at any point other than the three worst crashes in history – 1929, 2000, and 2008.

That’s true, IF you measure the CAPE ratio using CPI as Shiller does.  However, given the fact of Quantitative Easing, the M1 Money Supply has temporarily outstripped inflation.  At some point in the next few years M1 and CPI will resync, but until then the CAPE ratio needs to be measured against M1 to get a true picture of valuations.

In the following chart, the Shiller CAPE is in blue, and the M1 adjusted CAPE is in green:

Shiller’s CAPE ratio is a nosebleed 26.73, but the M1 adjusted CAPE is only 17.75 – which is still below the long term linear trend line on the graph.

In other words, when the inevitable bear market returns, it is unlikely to show up as a major crash.  A more likely scenario is a normal bear market, followed by another bull – with inflation rearing its ugly head around the end of this decade.




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