High EY valuations
It is first important to examine why high
earnings valuations are not necessarily a sign the
market is due to drop.
That is because these
valuation metrics are poor buy and sell signals.
Take, for example, the frequently quoted Shiller
multiple which, at 31 times ten-year average
earnings, is double the long-term average and
near the level it reached just before the 1929
crash.
Certainly, the multiple has its uses and
there is no doubting the correlation between low
valuations and high future returns, and vice-
versa.
However, history shows the Shiller
multiple is terrible at indicating the right time to
buy and sell. In fact, if an investor had bought
the S&P 500 when the multiple fell below its
long-term average and sold when it rose above,
they would have held shares for just eight
months in the last three decades. That would
have seen them miss out on most of the 20-fold
total return the market has experienced.
Even if perfect hindsight could apply buy and sell
thresholds at diferent levels, the result is almost
always signifcant underperformance. Heady
earnings-based valuations then, do not
necessarily signal future danger.
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