As North Korea Jolts Markets, Investors Look to Shiller PE Ratio for Signs of Overvaluation
U.S. and global stock markets have come under intense selling pressure this week, as concerns over a North Korea standoff dampen investor sentiment.
Global Stocks Follow Wall Street Lower
The selloff that began on Wall Street after Labor Day has extended into Asia. Japanese stocks are down across the board on Wednesday, with the benchmark Nikkei 225 falling 0.3%.
In China, the Shanghai Shenzhen CSI 300 Index is down around half a percent. Hong Kong’s Hang Seng Index has plunged more than 1% through the midday.
Equity futures in Europe are also in the red, pointing to a volatile start to the European session.
U.S. stock markets resumed trading on Tuesday after the Labor Day long weekend. The benchmark S&P 500 Index fell 0.8% to 2,457.85, with eight of 11 sectors contributing to the decline. The Dow Jones Industrial Average plunged 234.25 points, or 1.1%, to 21,753.31. The technology-heavy Nasdaq Composite closed off 0.9% at 6,375.57.
The S&P 500 and Dow are coming off their fifth consecutive monthly gain in August. Meanwhile, the Nasdaq has finished higher in nine of the past ten months.
Are U.S. Stocks Overvalued?
Overvaluation risks continue to haunt U.S. equities. Wall Street has risen nearly 20% since the presidential election last November.
This has prompted a logical question: Are U.S. stocks 20% overvalued?
In the eyes of Nobel Laureate Robert J. Shiller, the answer is yes. Earlier this year, Shiller argued that his measure of the P/E, known as the CAPE, was at a comparable level to the one achieve just before the 1929 market crash. CAPE essentially refers to the ratio of current price to average annualized earnings over the past decade. In Shiller’s view, a high CAPE is generally followed by low subsequent returns.
The Shiller PE Ratio is presented below:
This view is even more coherent when we look at the underlying fundamentals that have guided the market higher. While earnings have certainly played a part in the equities rally, the uptrend has been largely guided by hopes of faster economic growth under the Trump regime.
The U.S. economy grew 3% annually in the second quarter. That was the fastest quarterly expansion in over two years. The caveat is that it followed another mediocre quarter, where GDP growth amounted to a mere 1.4%.
In other words, hope and expectations are fueling the equity boom. As Wall Street’s major banks have argued, there is only so much investors can ignore before the tide begins to turn.
September is a notoriously difficult month for stocks. The next four weeks may prove especially taxing, as geopolitical risks and a congressional battle over the budget sway market opinion.