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Tom Armistead
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I am a retired accountant, having spent the early years of my career in the insurance industry and the later part in the field of accounting. My insurance experience has given me the willingness to accept investment risk if I feel the return justifies it; also, an interest in applying risk... More
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Tom Armistead's Instablog
  • CAPE Since 1987 As A Predictive Tool  3 comments
    Jul 15, 2012 5:38 AM | about stocks: SPY

    The following chart demonstrates that CAPE has considerable explanatory power with respect to 10 year returns, provided the data used is from the modern era, which I define as commencing in 1987, the year of the first computerized market crash.

    (click to enlarge)

    The R2 is 0.78, high enough to get some respect. If data from prior periods is added, R2 declines significantly. I believe the explanation lies in the combination of more stable monetary policy and quicker communication of data.

    Disclosure: I am long SPY.

    Stocks: SPY
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Comments (3)
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  • bbarberayr
    , contributor
    Comments (218) | Send Message
    Tom, what is CAPE predicting going forward?
    16 Jul 2012, 11:08 AM Reply Like
  • Tom Armistead
    , contributor
    Comments (6225) | Send Message
    Author’s reply » That depends on the period of time used. I use the period from 1987 forward, and arrive at expected returns for the next ten years of 7.33%.


    I also use a logic based method, based on E10, 10 year treasuries, a risk premium, and a growth element. I arrive at 7.69% (again for 10 years) by that method, after looking for earnings on the S&P 500 to reset to $75 per year and then go forward at 6.5% per year from the lower base.


    Those who advocate using longer periods of CAPE data, such as from 1871, will accuse me of data-mining, and see much lower returns.


    My thinking is, CAPE doesn't adjust for real growth, which is 2% per year, or better, on a long term average. As such, the E10 developed from Shiller's data is extraordinarily conservative. E10 is $62.53, by my calculations the last time I did it, and forward earnings per S&P are $102.62. Under the circumstances, I'm willing to accept a 5% return on the $62.53, plus I will pay up for the growth potential. So CAPE "should be" 20 plus whatever I see for the growth.


    I also look at the huge writedowns taken by Citigroup, AIG, et al in the 4th quarter 2008 and again that makes the E10 very conservative, since another epic disaster is unlikely within the next 10 years.
    16 Jul 2012, 11:47 AM Reply Like
  • bbarberayr
    , contributor
    Comments (218) | Send Message
    Interesting table on CAPE and returns in case you didn't see it:

    24 Jul 2012, 07:47 AM Reply Like
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