When it comes to evaluating whether the stock market is fairly valued, the ‘Rule of 20’ is a heuristic that some investors use as a guideline. This rule suggests that when you add the price-to-earnings ratio (P/E) of the S&P 500 to the annual Consumer Price Index (CPI) inflation rate, a sum total of 20 indicates fair value.

In recent times, there’s been an indication that the S&P 500 is becoming more expensive. This is observed when the combined total of the market’s P/E ratio and the CPI’s year-over-year increase exceeds the threshold of 20. A higher sum implies that stocks are priced above what would be considered fair value according to this rule.

However, this rule is not without its complexities, especially when considering the role of the Federal Reserve (the Fed) and its inflation targets. The Fed has an established inflation target that it considers to be a healthy level for the economy. If the Fed decides to alter this target, it could indeed shift the baseline for what is considered ‘good inflation.’

Such a change would have implications for valuation benchmarks like the Rule of 20. If ‘good inflation’ is redefined to a higher or lower figure, it logically follows that the ‘fair value’ for stocks could be recalibrated as well. In other words, if inflation expectations are adjusted, the sum total that indicates fair value might no longer be 20.

It’s important to recognize that while the Rule of 20 can provide a quick snapshot of market valuation, it is not a definitive measure. It is one of many tools investors might use, and it should be considered alongside a wide range of economic indicators and market factors. Moreover, the market’s valuation is influenced by a myriad of elements, from macroeconomic conditions to investor sentiment, and no single rule can account for all these variables.

As always, when it comes to investing, it’s vital for investors to perform their own research and consider a diverse array of perspectives and tools. The Rule of 20 is a useful starting point, but it’s not the final word on market valuation.