P/E10 at 39.5: Only the Tech Bubble Matched This Setup

The monthly valuation check on US stocks keeps landing in the same territory. Extreme. The P/E10 ratio, which measures stock prices against average inflation-adjusted earnings over the prior decade, sits at 39.5. Year-over-year inflation runs 4.55%. The 10-year Treasury yield is 4.47%. That three-part combination has only one match in modern market history: the tech bubble of the late 1990s, according to Crestmont Research data.

Crestmont tracks the relationship between the P/E10 and inflation going back to 1881. The data shows a clear band. When year-over-year inflation stays between 1.4% and 3.0%, the market tends to support higher valuations. That is the sweet spot. Outside it, valuations compress. Today inflation is more than 150 basis points above the top of that band. The P/E10 of 39.5 puts it in what Crestmont calls "extreme valuation territory."

The yield context matters. From 2009 to early 2020, the market operated in uncharted waters. P/E10 readings above 20 paired with 10-year yields below 2.5%. That combination had no historical precedent. The current yield of 4.47% marks a return to a more familiar pattern. Elevated valuations now coexist with meaningful bond income. The scatter plot of P/E10 versus 10-year yield from 1960 onward shows the post-crisis cluster as a clear outlier. Today's dot has moved back into the cluster that includes the late 1990s and the mid-2000s.

Ed Easterling, president of Crestmont Research, has long argued that the relationship between valuation and bond yields only became consistent after Treasury yields started responding to inflation in the early 1960s. By that measure, the present combination of a 39.5 P/E10 and a 4.47% yield is not an anomaly. Crestmont's data shows the only other period with a similar combination of P/E10, inflation, and yield was the late 1990s.

The period that followed is a reference point. The S&P 500 peaked in March 2000 and then fell 49% over the next two and a half years. The Nasdaq Composite lost 78%. The current setup does not guarantee a repeat. It does mean that expected returns from current levels are lower than historical averages, and the margin for error is thin.

The earnings yield on the S&P 500, the inverse of the P/E ratio, stands at about 2.5%. The 10-year Treasury yields 4.47%. Stocks offer no yield advantage over bonds, a rare condition. The equity risk premium is near zero.

For fixed-income investors, the 10-year yield at 4.47% offers a real yield near zero after inflation. That is a sharp contrast to the negative real yields that prevailed during much of the post-crisis period. Treasury ETFs such as Vanguard's VBIL and VGIT provide exposure to short and intermediate maturities, while VGLT covers the long end. The choice between them depends on the investor's view of where inflation and the economy are headed.

The June CPI report, due in mid-July, will provide the next update on inflation.