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Based on the Shiller P/E, 99% of the return in the first half was driven by valuation increasing, and 1% by the underlying companies producing value. The 36.3x multiple is 68% above its fifty-year average, and 38% above its twenty-year average. For historical reference, prior peaks were 29.1x in September 1929, 45.5x in April 2000, and 39.6x in 12/21.
There were two big issues last quarter that captured investors’ attention. The first was interest rates. The second issue that has rightfully held investors’ interest is geopolitics. Sentiment has moved around over the last several quarters. It now has shifted to convinced optimism. Very few people are expecting a recession now, and some have already begun their victory dance, complete with taunting the naysayers.
As we turned the calendar to 2024, it was 48% above its 50-year average and 21% above is average over the last 20 years, up from 35% and 11%, respectively a year ago. This trails only 1929, 1999-2000 and 2021 for the highest valuation in history.
The economy could get significantly worse, and investors should not panic when headlines turn from complacent to catastrophic. Economic cycles come and go.
Strong earnings could be a result of pent-up demand from COVID lockdowns and massive fiscal and monetary stimulus, high inflation with labor not catching up yet, and very low interest rates keeping interest expenses low. We see all these trends winding down, posing a threat to earnings growth.