As a follow-up, I ran a simple test of the payoff to market timing, using the Shiller CAPE and actual trendy boutique returns from 1927 to 2016. At the start of every year, I first computed the median value of the Shiller CAPE over the previous fifty years and assumed an over priced threshold at 25% above the median (which you can change). It is one of the best companies in the world, and it stands out as one of the best stocks you can buy to start the new year. In fact, I can see a scenario where strong economic growth pushes T. bond rates up to 3% or higher and stock markets actually increase as rates go up. As you can see, bringing in the low treasury bond rates of the last decade into the analysis dramatically shifts the story line from stocks being over valued to stocks being under valued.
The Treasury Alternative (or how much are you afraid of your central bank?) If the reason that you are in stocks is because the payoff for being in bonds is low, that equation could change if the bond payoff improves. The old adage that it is cash flows, not earnings, that drives stocks is clearly being ignored when you look at any variant of PE ratios. 26) When replacing an existing asset, the cash inflow associated with the sale of the old asset and any related tax effects must be considered and accounted for in the analysis. Comparing the market price of a stock to its book value is a common way of fundamental analysis. Bitcoin Trust (GBTC) – GBTC continues to bounce with the price of Bitcoin. While the CAPE has risen for the market, from 20.52 in 2009 to 27.27 in 2016, as stocks soared during that period, the Price to CF ratio has remained stable over that period (at about 20), reflecting the rise in cash returned by US companies, primarily in buybacks over the period.
The notion that CAPE is a significant improvement on conventional PE is based on the two adjustments that it makes, first by replacing earnings in the most recent period with average earnings over ten years and the second by adjusting past earnings for inflation to make them comparable to current earnings. Both adjustments make intuitive sense but at least in the context of the overall market, I am not sure that either adjustment makes much of a difference. Of all of his creations, I find CAPE to be not only the least compelling but also potentially the most dangerous, in terms of how often it can lead investors astray. Air filters? Diesel? Yeah, but how much fuel can you store? So, at the risk of angering those of you who are CAPE followers, here is my case against putting too much faith in this measure, with much of it representing updates of my post from two years ago. If you are starting with less than $5,000, you should only buy a maximum of two stocks. The bad news is two fold.
There is both good news and bad news for those who use the Shiller CAPE as their stock valuation metric. The good news is that the fundamental proposition that stocks are more likely to go down in future periods, if the Shiller CAPE is high today, seems to be backed up. The amount and type of information that stock Future gathers depend on the nature of the interaction. Professional advisory firms always analyze the past movements of the commodities to offer knowledge for the future. Note that the correlation is close to one between the normalized PE and the CAPE, suggesting that the inflation adjustment does little or nothing in markets like the US and even the normalization makes only a marginal difference with a correlation of 0.86 between the unadjusted PE and the Shiller PE. If you choose not to buy stocks, your immediate option is to put your money in bonds and the base rate that drives the bond market is the yield on a riskless (or close to riskless) investment. Earnings on the S&P 500 dropped in 2015 by 11.08% and are on a pathway to decline again this year and if the rate of decline accelerates, this could put stocks at risk.