Thursday, April 24, 2014

Global & Historical Shiller CAPE Price To Earnings Ratios

Last weekend I read Mebane Faber's excellent new book Global Value, which is an extensive study on the Shiller CAPE P/E ratio. It moves beyond the United States CAPE ratio and reviews both historical and global values.

We have often reviewed the chart below showing the current overvaluation of the U.S. stock market in relation to the historical average (the line running through the center). The glaring anomaly in the chart is the massive spike seen in the late 1990's when the PE ratio crossed into the 40's.


As insane as the late 1990's period was, it pales in comparison to what took place in Japan during the late 1980's. The chart below layers the Japan P/E against the U.S. in 2000. Japan's stock market at its peak had a P/E ratio above 90! 


There are two things you can take away from this:

1. The U.S. market is overpriced against historical value metrics. This can be seen in the chart below, put together by John Hussman, which shows the U.S. market weighted against a broad basket of value metrics. Many of these metrics are now well above the 2007 peak. Buying into an overvalued markets historically had led to lower than average returns over a 7 to 10 year period (and a greater chance for negative returns in the shorter term). 


2. Overvalued markets have the chance to become far more overvalued before they come back down to earth. The U.S. market would need to almost double in price in order to get back to 2000 valuations. It would need to almost quadruple to reach the Japanese valuations of 1990. Is this possible? Of course it is.

By why would you want to take that chance? Why not invest in a more undervalued market with stronger long term fundamentals and just wait for capital to locate that value? 

The chart below shows the U.S. is currently the second most expensive stock market on the planet, trailing just behind Columbia. Click for larger image:


As just discussed, this does not mean that the U.S. market cannot become more expensive and other markets cannot become less inexpensive. Russian stocks are currently the second cheapest on the planet, but they recently suffered a single day 10% price decline! 

Looking at the markets from both a historical and global perspective helps you understand the truth behind how the U.S. market stands in terms of relative value.

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