Breaking News
Ad-Free Version. Upgrade your experience. Save up to 40% More details

U.S. Stock Market At Risk Of P/E Deflation

By ValueWalk (Jacob Wolinsky)Stock MarketsJul 13, 2021 02:47AM ET
U.S. Stock Market At Risk Of P/E Deflation
By ValueWalk (Jacob Wolinsky)   |  Jul 13, 2021 02:47AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items

According to Crescat Capital's latest commentary, the US stock market is at risk of P/E deflation.

The US stock market is 51% overvalued and at risk of a 34% decline. The catalyst is inflation which has arrived in spades and is likely to stay for a while. We think shrewd investors should be getting positioned now for the Great Rotation to both protect against and profit from this critical macro shift.

Inflation is likely to be one of the defining characteristics of this decade, and anything but short-term, as the Fed’s recent spate of “transitory” bluster would have trusting souls believe. An enduring trend of rising wholesale and consumer prices is likely to topple today’s stock market by deflating its historically high price-to-earnings ratio.

For proof that inflation deflates P/E multiples, look at the strong relationship between CPI and the earnings yield (inverse of P/E) of the S&P 500 Index over the last seven decades of data in the chart below.

S&P 500 Earnings Yield Vs CPI YoY
S&P 500 Earnings Yield Vs CPI YoY

Most importantly, note the high near-term risk to the S&P 500 posed by the sharpness of today’s upward inflationary divergence. While the stock market can be a good hedge against inflation over the long term, keep in mind that in overvalued markets, rising inflation can be a killer.

As we have shown in prior research, the stock market is as expensive as it was at major market tops in 1929 and 2000 and is just as speculatively over-owned and overbought.

Combine all the above with bearishly diverging market internals as flagged by deteriorating market breadth, and we have a panoply of ingredients that should be a blaring siren of a probable market downturn ahead.

S&P 500 Price Target: 2,903

At the current inflation rate of 5%, the target earnings yield for the S&P 500 is 6.6% based on the historical regression of earnings yield and CPI. This equates to a P/E of 15.2, far from its 3.3% earnings yield and 30.3 P/E today.

To arrive at our S&P 500 destination price, apply the target 15.2 multiple to Wall Street analysts’ current calendar year 2021 EPS estimates of $191, and voilà, Crescat’s current valuation-based target for the S&P 500 is 2,903.

This compares to today’s all-time high price of 4,370 for the same index. This is not sensationalism, but macro realism based on history, economic data, current fundamentals, and math. Keep in mind that it is a moving target based on these same factors.

Analysts Underestimating Rising Wage Pressure

We believe that we are being generous in using Wall Street analysts’ aggregate expected S&P 500 EPS of $191 as this would indeed be a new high for US large cap companies. Such earnings are not yet in the bag and could disappoint.

Analysts are bullish on the prospects for the COVID-19 stimulus-led recovery translating into record earnings. We are concerned that these expectations are too high because analysts do not appear to be factoring in rising inflation’s likely squeeze on corporate profit margins.

In the coming months and quarters, businesses are not only likely to continue to face rising costs of intermediate goods and services, but also rising wage pressures. We are particularly concerned about the underappreciated outlook for rising labor costs, a non-transitory inflationary force that, in our analysis, is only getting ready to take off.

Rent Affordability At Historic Extreme

US rent affordability is the worst it has ever been relative to wages. Similar near-record imbalances are evident with respect to housing prices. Worker remuneration is much more likely to rise (than rents or house prices fall) to cure this imbalance due to acute labor shortages.

Rents Too High Vs Wages Too Low
Rents Too High Vs Wages Too Low

Tight Labor Market

When it comes to macro indicators of a tight labor market, the ratio of job openings vs. new hires is at a record high. Even with waning government handouts post pandemic, wages will likely need to increase to incentivize people to go to work.

Ratio Of Job Openings Vs. New Hires
Ratio Of Job Openings Vs. New Hires

Other macro diffusion indices, such as the NFIB Small Business Job Openings Hard to Fill and Conference Board Jobs Plentiful vs. Jobs Hard to Get also show levels of historic labor imbalances that signal a coming jump in wage inflation.

Wage-Price Spiral

Ultimately, it is the economic phenomenon known as the “wage-price spiral” a reflexive loop that can keep inflation surprising to the upside for years that makes true inflationary cycles anything but short-lived. Investors will need to look to the decade of the 1970s for guidance.

Such economic reality has been deemed irrelevant by the investing behemoths that dominate the markets today. Too many investors have capitulated to the four-decade disinflationary trend and the over-used narrative that has come along with it based on advances in technology, globalization, and an aging population.

Congratulations to those who have profited from it by staying long and strong in stocks and bonds, particularly in the S&P 500 Index and the large cap growth and mega cap tech stocks that dominate it today. In our analysis, the disinflationary trend is unsustainable, has been way overdone, and is at major risk of reversing under a new regime that we call the Great Rotation.

The catalyst for this regime is rising inflation combined with investors looking out for their best interests in typical fear and greed fashion. We believe investors should get positioned ahead of what we view as a highly probable, if not inevitable, stampede.

An Inflationary Agenda

Our government is incentivized to underreport systemic inflation so that they can collect extra tax revenues on nominal growth while also containing inflation-indexed expenses. The Fed is a branch of government that supports it in these goals.

Inflation also helps reconcile historic debt-to-GDP burdens by boosting nominal instead of real GDP. But investors must figure these things out for themselves. They should not blindly trust Fedspeak or the conflicted mainstream financial media with its incessant parade of stock and bond market apologists.

These pundits can sound so smart and authoritative at times, but they do not always necessarily have an agenda that aligns with investors’ best interests. The Fed will not tell you that inflation is likely to be a problem, because then it is more likely to get completely out of its control.

Similarly, your broker or financial advisor will not tell you that the stock or bond market is overvalued, because then you are more likely to close your account. Meanwhile, the financial media must keep their money management customers happy, so you are not likely to hear the bear case from them too often.

It is not always easy, but good investors need to be able to cut through the smokescreen and discern some things for themselves. The truth is that a lot of what has worked investment-wise in favor of stocks and bonds over the disinflationary last four decades is not likely to work in this decade.

The Great Rotation

We believe forward-thinking investors will increasingly be selling historically expensive stocks and fixed income securities and buying true inflation-hedge assets, including commodities in scarce supply and high demand, and stocks in a narrow group of sectors such as energy and materials that offer both low valuation and high cyclical near-term growth prospects. This is what we call the Great Rotation.

The Conference Board’s 1-year forward inflation expectation survey just hit 6.7% the highest since March 2011, a time when the leading junior gold miners ETF (NYSE:GDXJ) was 236% higher.

As the chart below shows, it is still early in what is likely to be a rip-roaring bull market for gold and silver mining and especially our expertly crafted exploration-heavy portfolio.

Junior Gold Miners Vs Inflation Expectations
Junior Gold Miners Vs Inflation Expectations

U.S. Stock Market At Risk Of P/E Deflation

Related Articles

U.S. Stock Market At Risk Of P/E Deflation

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at’s discretion.

Write your thoughts here
Are you sure you want to delete this chart?
Post also to:
Replace the attached chart with a new chart ?
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Are you sure you want to delete this chart?
Replace the attached chart with a new chart ?
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.
Continue with Google
Sign up with Email