+ Healthy correction on stock markets or crisis?
This is an original press statement released December 2019.
Subject: Are stock-markets stable? A view from the CAPM theory.

Prices on almost all stock-markets went up in 2019. The usual comparison below between the theoretical unleveraged PE ratio and the latest actual price/earnings (PE) ratios in various countries, indicates healthy corrections.
Country1. Risk Premium
2019		2. Risk free rate
3. Discount rate
(1+2)		4. Capitalized Discount
rate =PE(100/col. 3)		5. PE local index, unweighted
end 2018		6. Difference
(col. 4-5)
NL6,00%(1)0,11%6,11%16,4.AEX, 6-9-2019: 22,5+6,1
BE4,00%(1)0,85%4,85%20,6BEL20, 13-9-2019: 15,9+4,7
DE3,35%0,2%3,5528,2DAX, 08-11-19: 17,7+10,5
FR4,17%0,74%4,91%20,4CAC40, 1-11-19: 17,8+2,6
UK1,32%1,55%2.87%34,8FTSE100, average 19: 16,0+18.8
US5,57%2,69%8.26%12,1DJ30, 29-12-2019: 19,3-7,21

The theoretical foundation of that comparison is based on the generally accepted Capital Asset Pricing Model (CAPM). That theory states that the correct discount rate in share valuation is the sum of a risk free interest rate + a risk premium. Column 1 contains the most recent risk premiums, based on the longest possible period (since 1900) as an average of all 7 calculation methods. Column 2 contains the risk free long term interest rate for long term government bonds at the start of the year. Column 3 contains the sum of both and column 4 the reciprocal, an unleveraged Capitalized Discount rate or theoretical PE. Column 5 represents actual PE-ratio's based on 2018 net company profits in each major local index. The last column 6 deducts column 5 minus 4, showing the difference between the theoretical unleveraged PE-ratio minus the actual PE. Positive differences in black hint at undervaluation, negative ones are shown in red and hint that markets are overvalued. However, before jumping to conclusions, some other factors should be taken into account.
(1)Note: All stock markets in 2019 showed strong increases. Price and interest levels are from year end only. That raises doubt about any figure if a year of strong price increases like in 2019 follows after a year of strong price decreases like in 2018, with year end 2018 at the bottom. For this reason we deemed it appropiate to correct Netherlands and Belgium where the effect was strongest.

  • Relative difference: In 2006, just before the credit crisis and using basically the same model, all markets appeared overvalued as shown here. The USA on top in 2006 with -9,2, more then 100% of the Capitalized Discount rate in column 4. Now, just after the last correction end 2019, a 'reassuring' but red -7,21 appears only in the USA as column 6 shows. All other countries are in black now contrary to last year where France and the Netherlands were in red.
  • Leverage: The comparison above is based on an unleveraged Capitalized Discount rate. Converting into a leveraged rate, implies sustainable leverage (equity/equity+loans) ratio's, even in the USA. In 2007 an unsustainable negative leverage was needed in all countries.
  • Interest and dividend rates: The risk free interest rate is still lower then average dividend returns in all countries except the USA.

    • Based on the facts above, the recent upwards stock market corrections in 2019 look more like a healthy correction on strong price decreases in 2018. Only in the USA remaining buffers to withstand panic became more fragile or gone.

    For any question please Email. All information is based on sources deemed to be trustworthy. All forward looking statements are subject to all required qualifications. Not any responsibility is taken for any conclusion.