Scenario Pulse Check: S&P Valuations

Current CAPE levels are at the high end, but rising earnings and 2008 earnings dropping out of CAPE could enable the market to keep rising.

The US economy is riding into 2018 on a high.

Fueled by low interest rates and low inflation, markets continue to make a historic rise. Unemployment is at its lowest levels in 17 years. International Monetary Fund stated 2017 “turned out to be the global economy’s best year since 2010” and anticipates the party will carry on through 2018 as the US and every major economy – the European Union, Japan, and China – are expected to grow.

With this steady growth, low-interest rates, and stable inflation the S&P CAPE ratio sits at 34. From the bottom of the Great Recession, the market is now topping charts and valuations look lofty.

Screen Shot 2018-01-30 at 4.41.08 PM.png

Alas, history puts a reality check on the situation. The last time the S&P CAPE ratio was at such heights during the tech-fueled growth of the 1990s. Though the 1960s bust wasn’t as dramatic as the dotcom bubble bursting, the pattern was the same – with every boom comes a bust.  The 1960s and 1990s bull markets are the only eras to compare to the current boom, and we shouldn’t assume history will repeat itself.

Within HiddenLevers, the S&P Valuations scenario takes this historical analogies into account and lets us explore how the market can move from here.

Cold War Build Up – 1960s


The 1960s started out with a slow-growing economy and an unemployment rate of 6.7%. In 1962 the market started to fall after Cuban Missile Crisis sparked Cold War jitters and a spat between big business (US Steel) and government (JFK administration) went public. “Kennedy’s Crash” resulted in the Dow Jones Industrial falling more than 6% in one day. Damage control came in the form of large tax cuts and in 1964 JFK signed a tax proposal to benefit businesses and wealthy Americans, as well as provide broader tax cuts for all taxpayers.

The economy started to trend up, and between 1962 and 1966 the Dow average nearly doubled and the S&P shot up 78%, with CAPE at 24. From 1964 onward, incomes increased, poverty fell, and unemployment was low. New technologies in the industrial and agricultural sectors helped increase productivity to reach new highs of at  6.6.%.  The 1950s bull market created the American Dream, but the growth and consumerism of the 1960s made the dream of a single-family home with a two-car garage in the suburbs a reality.

When Lyndon B. Johnson came into office in 1963,  he sought to create his own legacy. The Great Society created social welfare services including Medicare, Medicaid, food stamps, and education programs. As LBJ launched the war on poverty at home, the Vietnam War waged on, and the expenses from financing the Cold War and war in Korea continued to rack up. Government failure to raise taxes for spending on the Vietnam War and expansion of social services increased the deficit, leading to accelerating inflation of about 6% annually and recession.

1960s Time Period Duration (months) S&P % Delta Ending CAPE


Feb 1961
Dec 1969
106 +49% 19
Contraction Nov 1968
May 1970
18 -33%


Irrational Tech Exuberance – 1990s

As the Clintons like to remind us, the 1990s saw the longest period of expansion due to a counter-cyclical stabilization policy. The economy shook off the 1987 crash, but inflation remained volatile and the budget deficits left by the Reagan administration stifled growth.

In 1993 Clinton and Fed chairman Alan Greenspan sought to undo the deficit damage by reducing the purchase of federal debt and increasing private sector investment, which spurred labor productivity and pushed up wages. The deficit-reducing budget induced the Fed to maintain low interest rates, allowing the cycle of investment-full employment-rising wages to continue.

The economy grew faster than expected and the deficit smaller than expected, and the markets oozed optimism. Between 1996 and 1999 the S&P jumped 143% due in large part to the rise of the Internet, enticing DIY traders to join the dotcom hype. Everyone was buying anything dotcom and valuations reached absurd levels.

When it became clear in January 2000 that these dotcom darlings were mostly show and no action, venture capital dried up and the market turned negative. Despite a struggling market, the Fed raised rates putting downward pressure on the market.


Time Period

Duration (months)

S&P % Delta

Ending CAPE


March 1991
March 2001





March 2000
March 2003




The initial impact of the dotcom downturn on the S&P from March 2001-November 2001 was a 9% loss. March 2000 saw the highest S&P gains and CAPE 43, but by October 2002 the S&P fell 44% and the CAPE ratio to 22.

Current Valuations – 2018

The 1960s, 1990s, and today were able to expand because of consistent growth, low unemployment, low interest rates, and low inflation. But the nature of the business cycle demands an end to all good things.

Late 2000s

Time Period

Duration (months) S&P % Delta CAPE (current)

President Obama

March 2009
Jan 2018




While pundits worldwide wax poetic about causality, the real reason markets have been volatile at the end of January is because they are dealing with these historic milestones (read: resistance) – valuation multiples in the mid 30s, and a rally that is just two months shy of surpassing the fabled tech boom.

Lower Valuation Multiples Ahead – Say What? 

The lower earnings-per-share (EPS) associated with 2008 recession times have artificially elevated valuations. That’s right – by 2019 the EPS values from 2008 (17.3) and 2009 ( 57.5) (compared to 95.5 in 2016) will drop out of the 10-year calculations and level out CAPE. With this easing out of 2008/2009 recession era earnings the 2019 CAPE ratio is projected to sit around 25, still above the 24 average, but well below its current mid 30s levels. Earnings are not expected to reach new highs – EPS for the last 4 years was only 2.25% and median growth was 9.3% since 1990 – which will flatten PE ratios further.

Source: Standard & Poor’s, May 2017 *The Shiller 10Y CAPE in this chart is from May 2017 and was 29.
When this post was written the CAPE was at 33.

However, with the uptick in global growth and Trump’s corporate tax plan, earnings look to be on the upswing. A look at HiddenLevers Scenario Library, and we see the impact of Trump’s tax plan being 100% priced in, with the S&P just above 2,850. With rising earnings, an S&P piercing through 3,000 is foreseeable – Flatter PEs, markets keep rising.

The scenario which deals with this theme directly is S&P Valuations. At its current pace and 16% priced in, the S&P reflects these gains and a rising CAPE ratio, which could reach an irrationally exuberant 45. However, as 2008/2009 earnings drop out, and current earnings rise, valuation multiples flat line in the low 30s.

Screen Shot 2018-01-30 at 2.53.28 PM.png

As we dance in the outer limits of the boom-bust cycle, global markets are rising together, which means central banks actions will also converge. Is there a soft landing coming for what might be the largest expansion in American history? Neither the 1960s nor the 1990s saw a soft landing, so why would you expect one here?

Get a HiddenLevers demo account to see how your models and portfolios might look under different outcomes of the S&P Valuations scenario.

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One thought on “Scenario Pulse Check: S&P Valuations

  1. […] Lately the FAANG gang (Facebook, Apple, Amazon, Netflix, Google) is feeling the brunt of the market. With public mistrust and regulatory scrutiny threatening their freedom, serious risks loom for the FAANGs. But are these price shocks company-specific or a macro issue? Within HiddenLevers, the Tech Bubble scenario lets us explore how these macro conditions affect the market. […]

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