10 Charts On The PE10 Valuation

In my discussions, there has been a lot of debate and interest around valuations, particularly Price vs Earnings type valuations (given the uncertainty around the Earnings side of the equation).

Indeed, with the corona-crash, in a number of situations valuations have either gone from expensive to cheap, or from cheap to even cheaper. And in this type of environment where some of the valuation metrics have reached extremes you want to pay more attention than usual to valuation signals.

But back to issue of earnings, it's true there is fundamental uncertainty on the path of earnings through the pandemic. Probably the only thing people can agree on is that earnings will likely plunge. But for how long? and to what extent? and what will the recovery look like?

I don't have all the answers, but I do know one thing - eventually life will return to some version of normal. This is a new and unsettling event, but it also has many parallels or echoes in past events. 

Indeed, there are actually analytical tools designed specifically for this type of situation.

Enter the PE10:

PE10 = Price / Average (trailing 10 years earnings)

The PE10 helps investors look through the cycle/swings in earnings by using the rolling 10-year average of trailing earnings; providing a consistent and less volatile anchor.

As I will highlight below, the PE10 is a useful indicator for asset allocation and global equity strategy, and there are some really interesting signals right now, and a few important facts and caveats to pay attention to. So check out the 10 charts on the PE10 below and let me know what you think.

N.B. all of this analysis is conducted at the index level (hence "top-down" !!), and the conclusions and commentary while maybe useful/interesting - won't necessarily hold for any one individual given stock (for instance I can say with high confidence that there will be an equity market one year from now, but I can't say which companies will survive vs thrive!)

1. The Classic Chart: This chart has been in my investment strategy tool kit from the early days, and it is both simple and powerful. It shows the PE10 valuation indicator for the major chunks of global equities: the USA, Emerging Markets, and Developed Markets excluding the USA. The upshot is after trading to expensive levels, US equities have returned to more neutral levels (but more on the US market later in this article). Perhaps more interestingly though is the valuation gap that existed previously between the US and global ex-US, which has persisted through the crash (and is something I have documented extensively. The other key observations to note are 1. how the EM PE10 briefly traded as low as 2003 levels, and 2. the DM ex-US PE10 almost broke to a new all-time low. For investors who use valuation in their process, things are getting interesting! 

(Click on image to enlarge)

 2. Global PE10 Quartiles: Sticking with global equities, the next chart shows the upper/lower quartiles and median PE10 valuation across countries. The sharp reset in the median country PE10 (across 47 countries) is stark, significant, and should not be taken lightly.

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