Home 2022 Follow Shiller’s CAPE Ratio and the Market Will ‘Smoke You’

Follow Shiller’s CAPE Ratio and the Market Will ‘Smoke You’

by Paul Ebeling

#CAPE #Shiller #stock #valuation

$SPY

“The CAPE ratio is a widely-followed stock market valuation and investing metric. And it is being talked about more as investors wonder whether stocks are poised to retrace in Y 2022. But, the signal of doom it sends is a myth“– Paul Ebeling

CAPE, or cyclically adjusted price-earnings, was popularized by Nobel prize-winning economist Robert Shiller. It is calculated by taking the price of the S&P 500 and dividing it by the average of 10 yrs’ worth of earnings. When CAPE is above its long-term average, the stock market is thought to be way overvalued.

Many market watchers use above-average CAPE readings as a signal that stocks should underperform or even fall as it reverts back to its long-term line. Fact is, CAPE’s line does not have much pull.

“While valuations feature importantly in our toolbox to estimate forward equity returns, we should dispel an oft-repeated myth that equity valuations are mean-reverting,” Goldman Sachs analysts wrote in a note to clients last wk.

The Goldie analysts did the math, and the Key metric to look at is the statistical significance.

The statistical significance over the full sample is 26%. This means that there is only 26% confidence that the Shiller CAPE is mean-reverting, and 74% confidence that it is not. The traditional threshold to consider a relationship statistically significant is 95%.

In other words, you can’t rely on CAPE to gravitate toward any mean.

The GS analysts took issue with the concept of the CAPE ratio in general.

“Even if we ignored this threshold, the time between valuations crossing into their 10th decile and reverting to their long-term average is beyond a reasonable investment horizon for a tactical decision,” they said. “For example, the Shiller CAPE entered its 10th decile in August 1989 but did not revert to its long-term mean for 13 years.

In other words, trading based on the assumption CAPE will mean-revert could lead to indeterminate yrs of getting smoked by the market.

Valuation metrics like CAPE and forward P/E offer a simple way of estimating the premium an investor pays for a company’s earnings so it is not totally worthless.

But, is does not do a super job of telling investors what stock prices will do in the coming days, months, or yrs. So tune out the Noise!

Have a happy, prosperous holiday weekend, Keep the Faith!

You may also like

logo-white

Your Trusted Source for Capital Markets & Related News

© 2023 LiveTradingNews.com – For The Traders, By The Traders – All Right Reserved.

The information contained on this website shall not be construed as (i) an offer to purchase or sell, or the solicitation of an offer to purchase or sell, any securities or services, (ii) investment, legal, business or tax advice or an offer to provide such advice, or (iii) a basis for making any investment decision. An offering may only be made upon a qualified investor’s receipt not via this website of formal materials from the Knightsbridge an offering memorandum and subscription documentation (“offering materials”). In the case of any inconsistency between the information on this website and any such offering materials, the offering materials shall control. Securities shall not be offered or sold in any jurisdiction in which such offer or sale would be unlawful unless the requirements of the applicable laws of such jurisdiction have been satisfied. Any decision to invest in securities must be based solely upon the information set forth in the applicable offering materials, which should be read carefully by qualified investors prior to investing. An investment with Knightsbridge is not suitable or desirable for all investors; investors may lose all or a portion of the capital invested. Investors may be required to bear the financial risks of an investment for an indefinite period of time. Qualified investors are urged to consult with their own legal, financial and tax advisors before making any investment. Knightsbridge is a private investment firm that offers investment services to Qualified Investors, Members and Institutions ONLY. Qualified Investors are defined as individuals who have met those Qualifications in the relevant jurisdictions. Members are defined as individuals who have been accepted into the Knightsbridge membership program. Institutions are defined as entities such as banks, pension funds, and hedge funds. If you are not a Qualified Investor, Member or Institution, you are not eligible to invest with Knightsbridge. All investments involve risk, and there is no guarantee of profit. You may lose some or all of your investment. Past performance is not indicative of future results. Knightsbridge is not a registered investment advisor, and this disclaimer should not be construed as investment advice. Please consult with a qualified financial advisor before making any investment decisions. By accessing this website, you agree to the terms of this disclaimer. Thank you for your interest in Knightsbridge.