Friday, January 12, 2018

On the CAPE

Winding roads that seem to beckon you
Miles of green beneath a sky of blue
--Patti Page

As observed here, there have been only three periods where the cyclically adjusted price to earnings (CAPE) ratio of the S&P 500 Index has been north of 30:

1) August to September, 1929
2) June 1997 to March 2002
3) Now

The previous two periods suggest a couple of things. One is that time above 30 can be short (one month in 1929) or long (five years from 1997 to 2002).

The other thing is that once the CAPE peaks, it falls a long way. After its 1929 peak, CAPE fell about 80%. After the 2000 peak, the ratio dropped by about half. Moreover, those declines tend to occur rather quickly.

As CAPE founder Robert Shiller has observed, earnings growth is often highest just before big market declines. The same holds true for valuations.

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