Asset Allocation: Real Yield after Inflation

This valuation strategy shows how cheap or dear different assets are in real terms after allowing for inflation.  Depending on the asset class this will be interest rate, bond yield or cyclically-adjusted earnings yield, the reciprocal of the PE ratio. (See also Yield / Earnings Yield)
 
The index is shown in as the thick white line on the right hand axis. The explanatory variable, the yellow line, uses the left hand axis. Our Best Guesses for future development of the valuation ratios are also shown on the left hand axis in orange.
 
Best Guesses suggest what would happen to the valuation ratios based on forecasts for interest rates, bond yields and company profits, assuming that prices remain constant. Interest rates and bond yields are consensus estimates. Earnings yield is based on econometric forecasts by ourselves.
 
For comparability, indices have been rebased to set year-end 1994 at 100, and the key economic time series has been rebased to set 1995 at 100. Please note the differences between charts in the Assets RouteMap and those for other RouteMaps. Since income is a major consideration for investment in some asset classes but not others, all indices are shown as total return and not in terms of price only, so as to make them compatible. 
 
Please note that comparisons between countries are of limited value owing to differences in the reporting of corporate profits. In general these ratios should be lower where there is a tradition of profit maximisation, as in Anglo-Saxon countries, than in other countries where the interests of outside shareholders may take second place to tax minimisation.
 
While this valuation ratio is important as the only comparable measure of current return, it has fluctuated wildly for many assets, so turning points have little predictive value, in terms of market timing. Nevertheless it provides important warnings of over-exuberance or panic.