P/E, PEG, Shiller P/E, and the Buffett Indicator

“Money, the denominator of every economic value, rapidly loses purchasing power due to inflation, driving equity prices higher and higher".

The stock market is widely seen as fundamentally overvalued by most analysts. This analysis examines how expensive stocks are today using several tools and indicators, and more specifically:

• Stock Market Capitalization to GDP (Buffett Indicator)

• Historical P/E ratios for S&P 500, Nasdaq 100, DAX 40, and NIFTY 50

• P/E/G Ratio for Nasdaq 100

• Historical Shiller P/E Ratio (CAPE) for S&P 500

Read more: Valuing the Stock Market with P/E, PEG, and Shiller P/E

Decoding the Cyclicality of Financial Markets

Financial markets tend to follow specific cycles. Over time, these cycles create recognizable patterns. Spotting these patterns can help improve investment decisions. Knowing when a market cycle may begin and end can be very useful for investors.

✅ Market cycles follow economic cycles, which are shaped by liquidity, inflation, and interest rates.

✅ A market cycle has two or four distinct phases. Each phase reflects specific trends that emerge during different economic conditions.

✅ Generally, a market cycle can range from six months to many years, or even decades.

Mature vs. Emerging Markets: What Sets Them Apart

Before moving forward, it is useful to examine the main differences between mature and emerging markets.

Volatility and the length of market cycles are the two main elements that set each financial market apart. As shown in the following chart, mature markets follow longer cycles, are less volatile, and offer lower risk/return ratios than emerging markets.

Read more: The Cyclicality of Financial Markets and Benner’s Cycle

The Economic Confidence Model & Global Financial Interconnectivity

Historically, economic growth moves in cycles, with phases of steady expansion followed by contraction. Financial markets follow this pattern as the wider economy shapes interest rates and, in turn, liquidity conditions across global markets. In earlier articles, we looked at models of business cycles, such as:

🔗 Ray Dalio Economic Cycles

🔗 Gann’s Law of Vibration

🔗 Benner’s Cycle

Below, we look at another model: Martin Armstrong's Economic Confidence Model (ECM).

Highlights of the ECM

• Armstrong claimed that economic cycles follow a constant ratio based on 𝜋 = 3.14.
• He also argued that financial assets do not rise in a straight line over time but instead follow an 8.6-year cycle (3,141 days, or 𝜋 × 1000).
• According to him, there is a larger 51.6-year cycle made up of six waves (6 × 8.6 years = 51.6 years).

Read more: Martin Armstrong's ECM Model Based on Pi {π = 3.141}

The MOVE Index as a Predictor of Market Volatility and Financial Distress

The MOVE Index tracks U.S. interest rate volatility and can provide an early signal of shifting risk sentiment in the bond market and the wider financial markets, before it shows up in equities.

Key Takeaways

• MOVE is like the VIX for bonds, with a strong track record of reflecting bond market sentiment (🔗 Treasury Bills)

• MOVE can be used alongside the VIX (explained later) to gauge overall market risk and investor sentiment.

• The bond market often signals major changes before the equity market.

Introduction to the MOVE Index

Created in 1988, MOVE stands for ‘Merrill Lynch Option Volatility Estimate’ and is designed to track U.S. Treasury yield volatility implied by current prices of 1-month OTC options.

Read more: The MOVE Volatility Index and its Correlation with the S&P 500

In late 2023, the famous Breadth Thrust indicator flashed a bullish signal for the stock market. Since the Second World War, it has only happened a few times. But why is this important?

What is the Breadth Thrust Indicator?

Developed by Marty Zweig, the Breadth Thrust is an indicator that analyzes the general momentum of the stock market to reveal the times when buyers begin to dominate the market. The indicator calculates the proportion of advancing/declining stocks and is widely known for its signal at the beginning of a new bull market.

Calculating the Zweig Breadth Thrust

Mr. Zweig created the indicator by tracking the proportion of advancing/declining stocks (AID ratio) over ten days. The indicator is based on the NYSE and tracks moments when oversold market conditions quickly shift to extremely overbought.

The signal for the new bull market

When the Breadth Thrust indicator moves from below 40% to above 61.5% within 10 days, it indicates the beginning of a potential new bull market.

■ From below 40% to above 61.5% (within 10 days)

Formula

The Breadth Thrust is simply the 10-day moving average of the following formula:

🧮 ( Advancing stocks ) / ( Advancing stocks + Declining stocks )

Read more: Marty Zweig & the Breadth Thrust Signal for the Stock Market