Chart of the Week: US assets showed signs of overpricing before sell-off

The markets sell-off since President Trump’s ‘Liberation Day’ tariff announcements took hold in an environment where, as Fathom has previously suggested,[1] US stocks were supported more by sentiment than by fundamentals. Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio produces a valuation multiple by dividing the current price of the S&P by its inflation-adjusted average earnings over the past 10 years. It can provide clues as to whether the market is relatively over- or undervalued compared with historical earnings. The chart shows the CAPE ratio plotted against the five-year ahead returns of the S&P (annualised) from 1990 onwards. Both variables are on a monthly frequency. There is a strong negative correlation of -0.64 between CAPE and forward returns — that is, higher values of the CAPE ratio are associated with lower future returns. We can see that all CAPE values over 35 are typically associated with negative 5Y-forward annualised returns. The current value of CAPE is 35.6, having reached a high of 37.7 on 31 December 2024. In other words, one might argue that the elevated CAPE ratio was indicative that there was already a high likelihood of an eventual correction, even before the latest round of tariff announcements.

Refresh this chart in your browser | Edit the chart in Datastream

[1] https://lipperalpha.refinitiv.com/2025/01/news-in-charts-us-resilience-masks-deeper-global-instability/

The views expressed in this article are the views of the author, not necessarily those of LSEG.

______________________________________________________________________________________