The 'CAPE To Saving Rate' Ratio Signals A Terrible 2018 For U.S. Stocks

Atle Willems, CFA profile picture
Atle Willems, CFA


  • Surging P/E ratios and plummeting saving rates are hallmarks of bull markets.
  • During 2017, the U.S. stock market has been blessed by both.
  • But this blessing could easily turn into a curse in 2018 as P/E ratios cannot forever increase and personal saving rates cannot forever decrease.
  • As 2017 draws to a close, the ratio between the two has again reached euphoric highs indicating troubles ahead in 2018 for the U.S. economy and the stock market.

The very hallmark of a financial bubble is prices dislocating from current and historical fundamentals and reasonable expectations of future ones. For stocks, one such fundamental is GAAP earnings.

It is no secret that broad stock market indices move in cycles, partly caused by earnings. The cyclical nature of earnings explains why value investors focus on the underlying earnings power of a company. This is also in part the reason why these investors appraise the profitability of a company over time and do not solely base their decisions on whatever a company reported in earnings last quarter nor what it is expected to deliver in the next. Consequently, stock prices need to be compared to earnings over a longer period of time, and not just trailing 12-month earnings or expected earnings next year. Benjamin Graham recommended seven to 10 years (Security Analysis, 2nd ed, p. 686). Robert Shiller bases his CAPE (cyclically adjusted price earnings ratio) on 10-year inflation-adjusted earnings.

So when stock market prices dislocate completely from past earnings records, that is, when the P/E ratio surges and reaches record-high territory as is the case with the S&P 500 CAPE ratio now, it's time to pay attention no matter what the level of interest rates - especially when they are on the rise.

Source: Robert Shiller

What is seldom talked about however (in my experience) is the profound economic importance of changes in money supply growth and how much people save, both of which play major roles in determining the ups and downs of an entire economy as well as stock market prices.

When savings drop, people consume more than they earn. When this happens over a period of time, people not only consume wealth, but simultaneously eat away at the rainy day cushion. When the much needed credit - and monetary expansion, which make living

This article was written by

Atle Willems, CFA profile picture
Atle Willems, author of "Money Cycles", is an analyst with Liabridge Economic Research. He holds a masters degree in finance with distinction from Nottingham University Business School and a BSc in Business Administration from Drake University.

Disclosure: I am/we are long MYY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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