The Shiller Cyclically Adjusted Price to Earnings ratio (“CAPE” ratio) is getting a lot of play in the financial press as the “single best forecaster of long-term future stock returns.” Nobel Prize-winning economist Robert Shiller first published information on the CAPE ratio in 1998. While some may have used this measure as a reason to argue that the market is expensive and to stay on the sidelines for the last couple of years, one quote is worth keeping in mind. On May 17, 2011, Shiller stated:
Equity returns will be disappointing over the next decade.
From that date through December 31, 2013, two and a half years later, the S&P 500 Index total return is up 47.3% (15.9% annualized). The decade is far from over yet, but the market will have to fall a long way before the decade he refers to is disappointing. We’ll see, but it causes one to pause. (Source: Bridgeway)
Trying to time the market based on valuations can be…problematic. It is worth remembering that earnings do have some disadvantages. As stated by Bridgeway:
First, they can be manipulated by management. Second, since accounting standards change over time, a dollar of earnings in 1880 may not mean the same thing as a dollar of earnings in 1990 or in 2014.
At Dorsey Wright, price is the sole input into our models. We employ systematic models that allow us to adapt to price trends (relative strength allows us to identify the strongest of the trends). What is, is.
