Money and Finance

Buttonwood: Back to the Shiller p/e

ONE key reason why I have been pessimistic about the outlook for the US stockmarket is based on the use of the Shiller price-earnings ratio. Ben Graham, the doyen of securities analysis, devised a version of this measure, but it has become associated with Robert Shiller, the Yale professor who can claim credit for calling both the dotcom and housing bubbles in his book Irrational Exuberance. He maintains the data on his own website.

The Shiller version tries to eliminate the effect of the economic cycle on valuations; without it, stock markets look expensive when earnings collapse in recessions and look cheap when earnings are high in booms. So it averages earnings over 10 years, and adjust them for inflation; at the moment, the p/e is 21.5, well above the historical mean.

So what? The noted quant, Cliff Asness, head of fund management group AQR, published a third quarter commentary in which he looked at future equity returns when the Shiller p/e was at current levels. The average 10 year real return was just 0.9%. Indeed, if you rank years by Shiller p/es, then you get an almost perfect relationship between valuations and future returns; real returns when the Shiller p/e was at its lowest ranged between 10.3 and 10.4%.

Now Mr Asness points out that there is a danger of small-sample bias and that the standard deviation of results is quite high. Nor is the Shiller p/e much use as a market timing signal; it was already high in the late 1990s and got even higher by the spring of 2000.

- Links
Mohnish Pabrai, Guy Spier, and Michael Shearn on Investment Checklists [H/T ValueWalk... This is the video and transcript from their Value Conferences appearance early in 2014.] (LINK) Related book: The Investment ChecklistRichard Muller's Physics...

- Hussman Weekly Market Comment: The Delusion Of Perpetual Motion
Link to: The Delusion of Perpetual Motion“I am definitely concerned. When was [the cyclically adjusted P/E ratio or CAPE] higher than it is now? I can tell you: 1929, 2000 and 2007. Very low interest rates help to explain the high CAPE. That doesn’t...

- John Mauldin: Forecast 2014: The Capes Of Hope
Link to: Forecast 2014: The CAPEs of HopeLast week's letter focused on my 2014 outlook for the US stock market and highlighted an important, but controversial, measure for long-term valuations: Robert Shiller's cyclically adjusted price-to-earnings...

- Gundlach Dips Toe Into Uber-indexing
DoubleLine Capital LP plans to launch an enhanced index fund based on Yale University economics professor Robert Shiller's cyclically adjusted price-earnings ratio. The DoubleLine Shiller Enhanced CAPE Fund will use derivatives — either swaps...

- Hussman Weekly Market Comment: Anatomy Of A Bubble
Presently, the Shiller P/E stands at 24. Be careful how you interpret the data in the table for Shiller P/E's above 24, since these levels were almost never observed in data prior to the late-1990's market bubble. You can see the odd effect of...

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