June 2020: Market Valuation, Inflation and Treasury Yields

Note: The charts in this commentary have been updated to include the latest monthly data.

Our monthly market valuation updates have long had the same conclusion: US stock indexes are significantly overvalued, which suggests cautious expectations on investment returns. In a "normal" market environment -- one with conventional business cycles, Federal Reserve policy, interest rates and inflation -- current valuation levels would be a serious concern.

On March 9, 2020, the 10-year Treasury yield hit its all-time low of 0.54%. As of June 30, it was at 0.66%. With this new low, let's take another look at the popular P/E10 valuation metric.

Here is a scatter graph with the market valuation on the vertical axis (log scale) and inflation on the horizontal axis. It includes some key highlights: 1) the extreme overvaluation and irrational period of the Tech Bubble, 2) the valuations since the start of last recession, 3) the average P/E10 and 4) where we are today.

P/E10 and Inflation Scatter

The inflation "sweet spot", the range that has supported the highest valuations, is approximately between 1.4% and 3%. See, for example, the highlighted extreme valuations associated with the Tech Bubble arbitrarily as a P/E10 of 25 or so and higher.