Is Cyclically Adjusted Price Earnings Ratio A Better Indicator?

I just finished watching a good little interview of Rober Shiller:

Shiller: Stocks Not Yet Cheap Enough For Me

 

I think it is interesting to note the interest rate levels when the CAPE reaches its bottom, it seems to correlate with interest rates peaking. Given that this CAPE is based over 10 years this might be reflective that the real turning event is the high levels of inflation that are brought on by the loose monetary policy that central banks employ in order to stimulate the economy, which ultimately requires higher interest rates to control.

What's other people's interpretation?

Either way it is quite a good article that pushes some really simple investing ideologies. Robert also has release some new figures on US and Australian property prices which are quite interesting.

 

Hi Chris,

Certainly Austin Donnelly believes that buying shares at a PE of less than 10 is a bargain!

Cheers,

Dan

 

But is that a PE ratio of 10 or a CAPE ratio of 10?

 

How is the CAPE calculated?

 

My understanding of CAPE is you calculate it just like you would a normal PE ratio except you take the average earning results of a company/index over a longer period (often 10 years) to smooth the the influence of the business cycle on the earnings results then and compare it to the share/index price.

For exampe, given the current situation it is highly likely that at the end of this recession the PE ratio for the ASX 200 will be below 10 because most companies earnings will fall significantly in this period (more than their share price), and there will probably even be companies that post significant losses which would represent negative earnings meaning it isn't useful to calculate a PE ratio for such companies. So a CAPE is used instead.

Looking at Shiller's figures using CAPE for the S&P 500, it is currently sitting at 15.3 which, historically, is a pretty fair value for shares, though obviously given the situation you'd expect that prices will probably fall considerably further as they tend to overshoot in downturns.

I also find it very interesting to note that the above graph really highlights that since the tech crash the US markets have never really returned to their strong growth levels. As I have said a few times in other threads I won't be surprised if historians write this chapter of stock history as the bear market that started in 2000.

 

"I also find it very interesting to note that the above graph really highlights that since the tech crash the US markets have never really returned to their strong growth levels."

So – where is the rest of the chart (from 2000 to 2009)
Is it possible that Shiller is still in 2000 and rest of the world is in 2009?.
Anyway, If you open S&P500 chart you may discover something...

 

I have no idea what you are getting at here - the chart is clearly posted above in the first post.

Call me a realist, but I don't count, currency depreciation versus other world currencies coupled with rampant inflation as "strong growth". Of it is easy to be fooled by the nominal figures which paint a very different story.

 

I think that you missed the point...
Following Shiller’s analysis on P/E ratio one would not engage the market between 2003/08 because P/E was too high at that time (around 30).
So by following P/E ratio alone one would miss one of the biggest bull run of recent years.
You are correct saying that it is easy to be fooled by the figures.
That is why I suggested S&P500 chart which illustrate how misleading Shiller’s P/E theory may be in relation to market movement.
After all it’s up to individuals to decide what to do – to follow academic theories or make money...

 

But you also would have missed being involved in the bear market that has the market at 12 - 13 year lows (that is also yet to bottom). Though I do understand your point.

I don't think Shiller was advocating that this chart should be used a model for the timing of the purchase or sale of stockss, rather it more clearly highlights the "irrational exburance" the markets can get caught up in over longer periods.

 

Standard PE ratio...

 

P/E ratio's as a tool for investing is pretty useless, it's really a meaningless stastic, and investors, professional or otherwise (read - amateurs like me), would be wise to disregard p/e's as a valid securities analysis.

 

So if you stay out of the market completely you miss both the highs and the lows!.. [Which I'm not advocating, just taking a tongue in cheek completion of the line of reasoning]

[Climbing up onto soapbox] In relation to the later posts about PE ratios - they're just one tool for comparing relative value of stocks, no more. The trouble with PERs is not that it's inherently flawed, just that human beings - with our need to relentlessly summarise and simplify and draw conclusions from incomplete data - use them the wrong way or in isolation. [Descending from soapbox now]

Cheers
N

 

It's definitely market crashes like these that will make the boring invest in government bonds look like as good as any other investment out there (though I'm expecting even bonds will have their day in the dog house in the not too distant future)...

But that's what we as humans do, we trying to find relationships and correlation between events - it's a one of the characteristics that makes us the dominant species of the world. It's just an issue of whether the coefficients of correlation are big enough to justify relationship between variables or was past related events just random suggesting that the real problem is the unknown variables that makes up our error term are big.