"Peak PEG" - The S&P Has Never, Ever Been This Expensive

Tyler Durden's picture

Authored by Francesco Filia via Fasanara Capital,

Measuring the Equity Bubble

In this brief note we discuss how, on some reasonable metrics, the S&P may qualify as the most expensive in history. When compared to potential economic growth, multiples on the S&P500 exceed even those seen during the Tech Bubble in 2000. To value the S&P index, we use a variation of the Shiller P/E and the Hussman P/E. In a simplistic form, the ‘Peak PEG ratio’ is a price to peak-earnings multiple, adjusted for long-run trend growth. It considers the highest (rather than average) earnings over the previous 10 years and then divides for growth potential. When measured against potential growth, even on its highest earnings, the S&P has never before been this expensive. It is 60% above its historical average fair value.

Firstly, using peak earnings instead of average earnings helps defuse one of the ordinary complaints to cyclically-adjusted Shiller P/E, or that it incorporates the bad earnings from 10 years ago, during the Great Financial Crisis, an outlier.

Secondly, the point we make is that the willingness of investors to pay up for future earnings - even the most generous one as multiples are projected against the highest such earnings in 10 years - must be related to potential GDP growth in the years ahead, as an historically-reliable proxy for earnings potential. It is one thing to buy 30x earnings if the economy grows furiously; it is quite another to spend that much if the economy slow-walks. The concept is commonplace in relation to single stocks (the PEG ratio), less so when market aggregates are considered. The thing is that long-run growth has declined for decades now, as is embroiled in the structural trends of Secular Stagnation: bad demographics (declining labor participation rates and shrinking working population in advanced economies), over-capacity and over-indebtedness, falling productivity of new credit, low productivity of labor and capital, disruption from new technologies (job displacement in primis). The downtrend in potential growth spans several decades; an inversion is possible but imprudent to factor in. To some, this is not a ‘new normal’ but rather an ‘old normal’, as the anomaly is perhaps growth in the half-century after WWII, while we now reverted to a lower average GDP growth of below 2%.

Source: Fasanara Capital ltd

Data Set:

  • S&P quarterly price data, source Bloomberg
  • Corporate Profits After-Tax, quarterly data, average of the two highest quarters over the previous 10 years, source FED St Louis
  • US Real GDP % Change, rolling 10-year average, quarterly data, source IMF

The Shiller P/E ratio

Professor Robert Shiller won a Nobel Prize for his studies on market inefficiency, as he discovered that stock prices can be predicted over a longer period. The Shiller P/E, or cyclically-adjusted P/E, or CAPE P/E, takes into account the average earnings of the last 10 years. Valued on P/E Shiller at 30x, US equities are in bubble territory. Only twice in history the Shiller P/E has been as high or higher, in 1929 and in 2000. If those were bubbles, and the market crash that followed may imply that, then this one is probably a bubble too.

However, critics to this ratio argue that it is distorted by bad earnings from 10 years ago, a time that may no longer be relevant.

The Hussman P/E ratio

John Hussman amends the P/E Shiller to counter its most common critic, and considers peak earnings instead of average earnings. He uses a ‘price to peak-earnings ratio’. He finds that the current market is more expensive than the market in 1929, although it is still less expensive than the one in 2000.

The PEG ratio for a single stock

Comparing multiples to growth potential is commonplace for single stock valuation. The price-earnings to growth ratio (PEG ratio) is a stock's price-to-earnings ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock's value while taking the company's earnings growth into account, and is considered to provide a more complete picture than the P/E ratio.

The Peak PEG ratio, using Peak Earnings and Trend Growth

The Peak PEG ratio uses peak earnings over the last ten years (the two top quarters), and adjusts them for long-run trend rate of GDP growth (here simply proxied by average of the past 10 years). It attempts to:

  • Uses top earnings so to conservatively assume the best profit generation capability for stocks in a decade to persist, thus defusing critics of distortion on bad outliers
  • Uses GDP trend growth so to proxy earnings growth potential, which is highly correlated to it over time. Thus, it compares expensiveness to economic potential. As a rationale investor , the higher growth in my portfolio’s future earnings, the more I should be willing to pay for it.
  • It also deprives the ratio from another common critic, that few stocks only lead the pack, distorting average P/E. As GDP growth proxies how big a total pie single stocks can eat out of, it should matter less how many stocks in the S&P500 join the move. Considering domestic GDP should also not impair the analysis, as world trend growth is likewise down-trending (secular stagnation is global phenomenon).

Variations on the theme:

  • Relating to Trend Growth other commonly-used valuation metrics such as Price to Sales, Market Cap to GDP/GVA/GNP, EV to EBITDA, Financial Assets to Disposable Income yields similar results, and does not falsify the thesis.
  • Relating P/E multiples to ‘velocity of money’ or ‘money multiplier’ as opposed to potential growth, as alternative proxies for secular stagnation, also leads to similar results.

Equities-to-Bonds ratio

So, equity markets in the US are expensive. On ‘Peak PEG’ metrics, they may have never been as expensive as they are today. The only metric left out there, where they look less expensive, is when compared to bonds: government bonds, corporate bonds, and now also junk bonds. Except that, bonds themselves are in a bubble, after $ 14 trillions of them got soaked up the last ten years by major Central Banks globally, now owning over 30% of total outstanding. Only the Bond Bubble then can justify equity multiples. Which is to say that only the Bond Bubble can justify the Equity Bubble. Meta-markets, where bubbles justify one another. A drunken man who drives home another drunken man. Prosaically, Equities valuations are not as insane as bond valuations, but that does not make them cheap.

How it ends

In our opinion, it ends like this.

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Anarchyteez's picture

Please crash!

My bets have gotten dusty.

DinduNuffin's picture

what happens when they own all the things?

TeethVillage88s's picture

Then poor child... we become English subjects under the British Empire...

Information Services:
http://research.stlouisfed.org/fred2/series/USINFO (2.65 Million down from 3.7 Million) All Employees: Information Services

Service Providing Industries:
http://research.stlouisfed.org/fred2/series/SRVPRD (119.5 Million) All Employees: Service-Providing Industries

http://research.stlouisfed.org/fred2/series/MANEMP (12 Million down from 19.5 Million) All Employees: Manufacturing

The Cooler King's picture

Who cares how fucking 'expensive' it is when you have a money printing FED that's run by jews, and a POTUS whose 'sugartitted' daughter seems to enjoy sucking the dicks of, & getting fucked in the ass by, self described CHOSENITES who, on their 'off days' like to buy buildings and proudly display them as '666PARK AVE"


What could POSSIBLY go wrong?


The Cooler King's picture

Oh, I probaly got downvoted by my serial junker there, so 'PROFITS 2 EARNINGS' look good... because mosley can only understand Obama logic & thinks Kushner is swell...

Fundies's picture

The suspense is killing my wallet. 

TeethVillage88s's picture

Perhaps the stats on total retail businesses declining is the best measure.

Data is several years old... click

http://research.stlouisfed.org/fred2/series/ROWFDNQ027S ($3.29 Foreign Investment USA)
http://research.stlouisfed.org/fred2/series/GPDI ($2.89 Private Domestic Investment)
http://www.bea.gov/newsreleases/international/intinv/iip_glance.htm ($31 Trillion foreign Ownership of US Property compared to $26 Trillion in US Ownership of Foreign Property) (This is very interesting as Big Banks are growing strongly, but the number of total us banks is dramatically decreasing, like someone is gaming the system, Commercial Banks in the U.S. - FRED - St. Louis Fed)

Rest of World http://research.stlouisfed.org/fred2/series/WCMITCMFODNS (2014:Q1: 3,003.34 Billions of Dollars) Rest of the World; Credit Market Instruments; Liability, Level
Total US Debt http://research.stlouisfed.org/fred2/series/TCMDO (2014:Q1: 59,398.59 Billions of Dollars) All Sectors; Credit Market Instruments; Liability, Level

http://research.stlouisfed.org/fred2/series/LNU05000000 (Not in Labor Force)
http://research.stlouisfed.org/fred2/series/civpart (CIVILIAN PARTICIPATION RATE)

TeethVillage88s's picture

Francesco Filia via Fasanara Capital,

Dude, we have printed to the moon!

- Asset prices increase as dollars are deflated
- yeah, it's a scheme
- yeah, it sucks
- yeah, it will cause a crash & USA will be the next Roman Empire to bite it

taketheredpill's picture

"Except that, bonds themselves are in a bubble, after $ 14 trillions of them got soaked up the last ten years by major Central Banks globally, now owning over 30% of total outstanding. Only the Bond Bubble then can justify equity multiples".


1. Every time the Central Banks bought bonds, equity prices tended to rise and bond prices tended to FALL.

2. Whenever the Central Banks stopped buying bonds, equity prices tended to fall, and bond prices tended to RISE.


So....if the Fed and all the other CBs announced tomorrow that they were going to reverse all the STIMULUS, would Equity prices Fall? Would Equity prices fall by a little or would they fall by a lot?  Could Equity prices even reverse the entire post GFC run-up?


Put another way, are (Government) bond yields as low as they are BECAUSE of Central Banks or DESPITE Central Banks.

order66's picture

People are only after yield so these types of metrics don't drive capital allocation. Unless the 10 yr spikes over 3%, no one's going to pay attention.

Thought Processor's picture



Maybe money ain't what it used to be.

How do you value assets if the currencies you are using to value them are themselves plummeting in value?  Is the S&P going up or is the dollar (and other currencies) going down?  Is real net economic output (in volume, not pricing) going up now?  Perhaps it's as simple as this: in a currency deflationary and asset price inflationary environment you simply want to own assets not the currency.

In this context expensive may be the new cheap, that is if the currency printing trend continues.


As we all know they are going to print their way out of this, whether it works or not is not really important to the people who are doing it.

Dr. Richard Head's picture

"They" don't care if it work unless those connected close to the spigot stay solvent. 

Stormtrooper's picture

"How do you value assets if the currencies you are using to value them are themselves plummeting in value?"

Correction.  How do you value assets if the currencies you are using to value them have absolutely no value except for the BTU heating value in the paper that they are printed on.

CorporateCongress's picture

Anothwe day another peak insanity 

JBilyj's picture

Wrong, relative to bonds, stocks are still cheap..

misterbulldops's picture

Um. When I looked up the definition of "peg", urban dictionary gave something very different...... 

RichardParker's picture

Market cap to GDP screams expensive!


(extend to April 2017 on graph)


starman's picture

Just back from Europe they wouldn' except my dollars on the plain or in restaurants! 

It was pretty embarrassing! 

vladiki's picture

A great time to exit the stock casino. You do NOT have to be in it! Cash is not for wimps. That's a silly myth promoted by the sellside pro's. Long phases the past 20 years when it's been the best investment and it is so again. DON'T LOSE MONEY is the mantra for today.

Bernankenomics never made sense, has not worked, we can see why, the setup is nuts. As we speak Yellen is doing eenie meenie miny mo to decide on rate rises. The Fed and other Central Banks are just winging it and trying not to show it, and to put the cherry on top are buying stuff to push up prices. That IS crazy-different right enough, but a trigger for the sane investor to get out, not to stay in.

There'll be plenty of time to get back in, in the next 1-3 years. Want to gamble? Play blackjack and obey the rules. But get out of this ridiculous market.

scubapro's picture



given the last straw in the bulls' hope chest is stocks earnings yeild is "better" than bond rates.......both stocks and bonds will decline together in the next 'crisis' (aka recession).    it should reduce the popularity of 'investing' amongst mains streeters to multi-generational lows, and likely scorn the millenials for a good 15 years.