Canada: Oye! Times readers Get FREE $30 to spend on Amazon, Walmart… USA: Oye! Times readers Get FREE $30 to spend on Amazon, Walmart…The recent correction/downturn in the stock market seems to have taken many investors, both big and small, by surprise. If one looks at historical stock market valuations, particularly price-to-earnings data, it is quite clear that the recent volatility to the downside should have been anticipated.
Robert Shiller, famed for his housing market index, has also accumulated a very large database of monthly price-to-earnings ratios for the stock market going all the way back to January 1871. This data set includes monthly stock prices, dividends and earnings data along with the consumer price index (CPI-U) that allows the data to be converted to real/inflation-corrected values. Stock price data are monthly averages of closing prices. From this data, Dr. Shiller calculates the CAPE or Cyclically Adjusted Price-Earnings ratio which is also known as the P/E 10 ratio. The CAPE ratio is defined as the price of stocks (or the stock market as a whole) divided by the moving average of ten years of earnings adjusted for inflation. Higher than average CAPE values suggest that there will be lower than average long-term annual returns and lower than average CAPE values suggest that there will be higher than average long-term annual returns on stocks. If you are interested, you can find Dr. Shiller's dataset here by clicking on the U.S. Stock Markets 1871 – Present and CAPE ratio. If you wish to see the individual CAPE value for any given stock, please click here.
Now, let's look at a graph that shows the CAPE value from 1881 to the present:
We can quite clearly see how volatile the CAPE ratio has been over the fourteen decades and can see how it peaked and and dropped prior to and during the Great Depression, during the tech sector boom and bust of the late 1990s and early 2000s and how the CAPE ratio dropped during the Great Recession. Over the past 134 years, the CAPE ratio has averaged 16.64 and has fallen in a range of between 4.78 in December 1920 and a peak of 44.2 in December 1999. According to Dr. Shiller's calculations, on August 3, 2015, the CAPE ratio was 26.45. According to this website, on Friday August 21, the CAPE ratio was 24.99. These values tell us that the stock market is still significantly overpriced compared to the 134 year average of 16.64 and that the recent correction should have come as no surprise to investors. In fact, at either 24.99 or 24.65, the present CAPE ratio is still in the top 10 percent of all valuations over nearly a century and a half.
Here is a graph showing what has happened to the CAPE ratio since the beginning of the Great Depression in December 2007:
Over the 93 months, the CAPE ratio has averaged 21.95 and has fallen in a range of between 13.32 in March 2009 and a peak of 26.99 in February 2015. At its current level of 24.99, the CAPE ratio would suggest that the stock market is still overvalued compared to its post-Great Recession average.
I can recall during the tech sector boom that many analysts suggested that the concept of price-to-earnings was no longer applicable to stock valuations, particularly since many tech sector companies had almost no earnings and extremely high valuations. As we learned rather painfully, this was not the case and Dr. Shiller's analysis proved to be correct in the long-run. At this point in time, it appears that the American stock market is still significantly over-priced when one compares present earnings to share prices to the levels experienced over the past century and that we should expect further volatility to the downside in the future.