Charts of the Month

CHART 1 – CAPE FEAR

There is some chatter that equity markets may be approaching another major cycle peak. And the chart below is one of the main reasons why.

It shows the S&P 500 cyclically-adjusted price/earnings (or CAPE) ratio, going all the way back to 1900.

It uses a 10 year average figure for earnings, which helps to smooth out short-term fluctuations in the business cycle.

Historically, a high CAPE has been associated with low subsequent returns and vice versa.

Taking it a step further, every time the ratio has risen above 30x, a major decline in the US stock market has ultimately followed.

So with a current reading of 38x there is reason for caution.

Encouragingly, this particular valuation metric is a lousy market-timing tool and there have been several past instances where high CAPE ratios have seen stock prices march on to much higher highs.

CHART 2 – MELT UP OR DOWN?

Is an equity market melt-up more likely than a melt-down?

For all the talk of frothy valuations and sentiment extremes, this year’s stock market rally appears pretty unloved.

The chart below shows how US money market balances continue to surge and now total well above U$7trn.

This is a good proxy for investor positioning because it shows cash holdings that could be owning bonds or equities instead.

So the scale of this upturn is firmly at odds with stock markets being on the verge of a major crash.

Typically, big drawdowns in risk assets only occur after investors have gone “all in” and have little cash left to invest.

With money market balances currently at record highs this suggests, if anything, a lot more buying power can be deployed into equity markets, particularly with the Federal Reserve now cutting interest rates.

CHART 3 – NOTHING TO SEE HERE

It’s easy to forget that stock markets tumbled earlier this year with headline indices seeing drawdowns of almost 20% during the first half.

The sell-off now looks like a blip, given the speed and scale of the rebound and most of the talk now is whether or not the bull market has run its course.

The chart below suggests not.

As we’ve noted before, the AAII Sentiment survey is a long-running series that captures how US investors are feeling about the stock market.

An extreme high in the net bullish reading reflects outsized optimism about future equity prices and typically suggests a major decline is on the cards.

The converse is true when sentiment is heavily depressed.

So the fact this indicator is currently bang in line with its neutral reading is actually a good thing.

Although it suggests the stock market is no longer “persona non grata” (typically a strong buy signal), it also rules out that we are at the euphoric stage of a bull market rally that usually implies a big drop is approaching.

CHART 4 – BORING BONDS, NO MORE

The fact it’s only been a few months since we last showed this chart proves just how important it is.

Investing is far too complicated to boil the market outlook down to a single factor, but long-dated US bond yields should be on the mind of every investor.

That’s because, throughout the past 50 years, every historic spike in US Treasury yields has been a precursor to a major equity bear market.

This occurred as recently as 2021/22, when the global inflation shock sparked a big increase in US borrowing costs that ultimately triggered the 2022 downturn in stocks.

Importantly, bond yields remain largely under control, despite lingering concerns over fiscal largesse and inflation.

This suggests the stock market rally can continue well into 2026.