Enjoy Your Weekend Reading on the CAPE

In our discussion of Mr. Market, we made passing reference yesterday to CAPE, Yale professor Robert Shiller’s 10-year cyclically adjusted price-earnings measure. This led to quite a conversation via a series of e-mails and Twitter posts from an assortment of analysts and asset managers. I received research from or by Cliff Asness, Michael Kitces, Mebane Faber, Jeremy Siegel, Salil Mehta, Stephen E. Wilcox, Doug Short, Wade Slome, Erik Kobayashi-Solomon, Ben Carlson and Jesse Livermore. If you want a crash course in CAPE, spend the weekend digesting what they have to say.

Today, I want to focus on the pros and cons of CAPE, giving airtime to all sides of the argument. My main interest in CAPE has more to do with behavioral issues such as confirmation bias by those who cherry pick CAPE as their preferred valuation metric when it suits their market position.

Let’s start with a few words about valuation and timing. Cyclically Adjusted Price to Earnings uses the prior 10 years of trailing per-share earnings rather than just the previous four quarters. This reduces the short-term volatility. In theory, it should include at least one full business cycle, and possibly more. Shiller has said that he was trying to develop a valuation metric that would tell an investor whether equities were likely to outperform their median returns during the next decade.  Continues here







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