AAII: The American Association of Individual Investors
By now, the regular reader is familiar with the Shiller CAPE ratio. For the rest of you, here is a primer.
Say the snp500 is at 2100.
Take the average of last 10 years earnings adjusted for inflation. Let is say this is 100.
So the cyclically adjusted price to earnings (CAPE) ratio is 2100/100.
The analysis of the article follows.
Re: Analysis of financial articles -I
Prof Stephen claims there is one error
He says 10 yrs too long. Business cycle is now 6 years. Not 10. To show proof he says :
Contraction duration is 5 yrs 6 months
Expansion duration 6 years.
Both < 10 years. So CAPE should use 6 yrs not 10.
Wrong.
Re: Analysis of financial articles -I
One business cycle should include expansion AND contraction. Per the Prof the CAPE only includes one or the other in extreme. Or parts of one and parts of the other.
Re: Analysis of financial articles -I
The Prof goes on to say
The last trough was in 2009. So by including data from 2006 April, we are underestimating the E. Since it includes the (latter half - my addition) of the contraction part of the cycle.
The CAPE is at 27.5. Long term CAPE average 16. So 70 pct overvalued. (He wrote article earlier. I am using current numbers since I don't recall when he wrote it. And don't want to keep switching screens).
Re: Analysis of financial articles -I
He says the p to e based on last year's earnings is 20. While long term average is 15. So 33 pct overvalued.
Then he explains the discrepancy due to the 10 yr being used instead of 6 years.
No prof. Using just one year for E subjects result to volatility. Especially if earnings aren't smooth. The 10 yr smooths it out.
Re: Analysis of financial articles -I
Of course since inflation adjustment is done, during periods of low inflation, the denominator will be lower. THAT COULD explain why the CAPE is higher than it should be . Hence overestimate degree of overvaluation. But you don't simply take one year earnings based p/E and draw conclusions. IMHO.
Re: Analysis of financial articles -I
The Prof. Also states something a bit incorrigible.
The P/E based on one yr earnings is not far from its average since 1988. While the CAPE is significantly higher.
Come on Prof. Why did you throw in 1988 as the baseline for one year p/e? We all know the P/E over last 21 to 25 years has been higher than LONG TERM p to e! I bet the average CAPE in the same time frame is also higher.
Something about apples to apples comes to mind.
Re: Analysis of financial articles -I
Still an interesting read.
Thank you.
Re: Analysis of financial articles -I
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Re: Analysis of financial articles -I
Can't open full article. Have to be AAII member. Was able to read full article first time.
Re: Analysis of financial articles -I
Interesting. I invest with my gut - if I feel it in my waters, I go for it!
Analysis of financial articles -I
Don't go with the masses is my advice.
Re: Analysis of financial articles -I
There is a pulse. God is great.
Analysis of financial articles -I
My advice is buy good companies getting punished by the markets due to missing so called forecasts or world events etc.
Re: Analysis of financial articles -I
My advice is buy good companies getting punished by the markets due to missing so called forecasts or world events etc.
Thanks Rizwan Fareed. Very good advice.