Shiller-CAPE and price-to-book ratio enable reliable forecasts on subsequent stock market returns. In countries with structural breaks, price-to-book ratio even exhibits some advantages compared to CAPE.

No other asset class - neither bonds, cash, gold nor real estate - has offered comparable return potential. Nevertheless, stock markets are subject to very strong fluctuations, and the achievable returns largely depend on the time of investment. Thus, the question for investors is how they can most accurately forecast long-term stock market developments.

The standard approach - forecasting a company's earnings development based on the economic development of a market and using the resulting stock market valuation to forecast the short- to medium-term stock market performance - is rarely successful in practice.

At best, economic developments can only be estimated roughly. The earnings growth of internationally-oriented companies is more and more decoupled from the economic cycle of their countries of origin, and short- to medium-term earnings growth correlates only very weakly with stock market developments.

Unforeseeable developments such as terrorist attacks, oil price shocks or central bank statements, and the resultant market sentiment have a much greater impact on capital market developments in the short to medium term than calculable fundamental data. Given this fact, valuation metrics such as the commonly used price-to-earnings ratio PEwhich looks at a market's corporate earnings in relation to current market prices, would not provide a reliable correlation to the next year's stock market earnings even if it were possible to make an exact forecast Figure 1.

Rather a pity, given the hordes of analysts who compete on a daily basis to get the most accurate earnings forecasts! There are also two reasons why classic PE is of almost no use in long-term forecasting. On the one hand, corporate earnings are extremely volatile - in practice, they can at best be predicted roughly.

Thus, the level of profit in any one year is not necessarily representative of the future development. Furthermore, PE always looks unattractive in times of crisis because of the lower corporate earnings, yet this is when the buying opportunities are most lucrative.

This is what scares Nobel Prize-winning economist Robert Shiller about the economy - MarketWatch

For these reasons, PE based on current or projected earnings is totally unsuitable as a forecasting tool. Fortunately, there are better forecasting tools than the classic PE. As far back asGraham and Dodd suspected that cyclical fluctuations in earnings could adversely affect the validity of PE. As a result, they recommended using a long-term average of historical earnings to calculate the PE. InRobert J.

Shiller, winner of the Nobel Prize in Economic Science, and John Campbell acted on this suggestion. As both above-average corporate earnings in economically strong years and high corporate losses in periods of recession are not sustained over longer periods of time, they developed a cyclically-adjusted price-to-earnings ratio. CAPE puts the current market price in relation to the average inflation-adjusted earnings of the previous 10 years.

Adjusted for an economic cycle, it duly measures whether the value of an equity market is high or low compared to its earnings level, to which it will very probably return.

The cyclically adjusted CAPE actually permits much more reliable long-term return forecasts than the classic PE. Over the past years, for example, the CAPE for the US stock market remained in the range of 10 to 22 in all but a handful of cases, often returning to its historical average of about 17 Figure 3.

The CAPE has significantly exceeded this range just four times: For each of these years, plausible reasons were given for why long-standing methods of evaluation should no longer apply, such as the introduction of mass production or the telephone, the departure from the gold standard or globalization.

Authors such as Siegel also provide a strong rationale for the current, significantly higher CAPE levels. All of these factors provide good reason for higher CAPE levels and only the future will reveal whether they actually herald a new era in evaluation terms, or whether Templeton's dictum once again holds true: One thing is certain: All the reasons given for higher valuations over the last years, no matter how plausible, have proven wrong: As a general rule, those who invested in these overvaluations experienced real losses over periods of years.

In contrast, those who invested during periods of attractive CAPE and pessimistic market sentiment always benefited from above-average returns in the long term. This correlation is not exclusive to the US market. In our recent study, " Predicting Stock Market Returns Using the Shiller-CAPE ", we dc universe online earn station cash evidence of comparable relationships in all the country indices surveyed for the period Despite much shorter assessment periods, different accounting standards and regional differences, the same applies to all countries: In Germany, for instance, attractive CAPE valuations of less than 10 were followed by real average median ifundtraders forex manual growth of In contrast, investors who historical euro canadian dollar exchange rate to commit funds at times when the markets were expensive, with a CAPE of over 30, would have posted gains of just 0.

The Japanese stock market, with its low correlation to other stock markets, stands out both because of its above-average CAPE - at times well above 50 - and its extremely negative subsequent returns.

Japan thereby improves the international relationship between CAPE and subsequent long-term returns. Assuming that this correlation holds for the future, current CAPE values can be used to make rough estimates of possible returns over the next years. Investors need to note that the Hong kong stock brokerage fee approach is based on the assumption that stock market earnings reverse to their year mean.

This cannot be assumed in small markets subject to structural breaks or in markets where earnings growth diverges significantly from the past. This is illustrated by the MSCI Greece, which currently has an extremely low CAPE of below 2: Over the past 10 years, the number of shares in the MSCI Greece has fluctuated between a low of robert shiller stock market in and a high of 20 in In the face of such variations, the question robert shiller stock market whether the aggregate corporate profits of these different companies adequately reflect the earnings strength of the 10 companies currently represented in the index.

Also, to what extent is a return to the year mean realistic, given that it was greatly determined by the high profits of a now defunct financial industry? A comparison with the broader and more structurally stable MSCI Greece Investable Market Index IMIwith a CAPE valuation that is several times higher, gives reason for doubt Figure 5.

In view of the above, it seems advisable to take a look at other key figures used for making 777binary review of option trading platform return forecasts, not just CAPE. The price-to-book ratio lends itself well to this since book values are less volatile than profits and cash flows, and require no year smoothing. This also eliminates the not unproblematic assumption of a comparable market structure over the preceding 10 years.

PB is also a good option because it brings an net asset value component to the table beyond CAPE's focus on earnings. Our results support this research not just in theory. Empirically, PB has been providing return forecasts of comparable accuracy to CAPE forecasts since Figure 6. It seems logical that an indicator frequently used as a value proxy at the stock level binary option on par 5 minute strategy correlates to a steady drop in the stock market is called returns at market level.

Probably, the only reason why PB is not used in practice as much as CAPE is because of missing data and the resulting inability to verify it empirically results for other indicators are shown here. This shows that CAPE and PB enable significantly more reliable long-term forecasts than correctly estimated long-term earnings growth rates for the karvy stock broking limited website 15 years.

Assuming that the relationships of the past years continue to hold true, current CAPE and PB values can be used to make long-term forecasts for international stock markets. The US stock market, for example, has a current CAPE value of In the past, valuations at these levels were followed by returns of on average 4.

As such, those investing in the US market in the hope of achieving high long-term returns need average return on the stock market historically have good reason for doing so, because this kind of growth would be at odds with the stock market experience of the past years.

In some European markets, however, including Germany, higher stock market returns can be expected. The German stock market, for example, currently has a CAPE of In the past, periods with comparable valuations were followed forex supply and demand book average long-term annual returns of 7.

At present, the emerging markets offer even higher expected long-term returns. Generally, however, the predicted performance is achieved not through a stable upward trend, but with strong fluctuations which can be described in terms of scenario analyses. Historically, returns of between 1.

The scenario corridor depicted in the chart does not just enable us to draw conclusions about possible long-term returns. It also provides information about medium-term risks and rewards, as well as the limits of fundamental subsequent return estimates.

The "worst case scenario" in the chart, showing the potential to correct down to points, corresponds to the lowest subsequent return ever measured for a comparable valuation. Although such a scenario - based on negative outliers - is highly unlikely, it does give us an insight into the impact of extreme events, such as world wars or severe depressions, as inand the effect they can have on price developments.

The distribution of returns in the German market is far more upbeat. In the past, subsequent returns of between 5. This would correspond to a DAX level of approximately 24, points. The chart shows that the DAX could fall to 8, points within the next three years, or rise to 18, points.

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Equity investment is not just the most lucrative long-term form of investment; taking inflation and liquidity into account, it is also one of the safest. This is especially true of times when valuations are attractive, as is currently the case in Europe and emerging markets in particular. At the moment, no other asset class can offer comparable potential. Campbell, John, and Robert Shiller. Journal of Finance, Vol.

Why Robert Shiller Is Worried About The Market | Zero Hedge

Journal of Portfolio Management, Vol. National Bureau of Economic Research Working Paper Dimson, Elroy, Paul Marsh, Mike Staunton, Jonathan Wilmot, Paul Mc-Ginnie. Credit Suisse Research Institute. Graham, Benjamin, and David Dodd. Theory, Evidence, and Illusion ". Anatomy of a Post-Crisis Value Trap ". Princeton University Press, Princeton, New Jersey. Online Stock market data used in " Irrational Exuberance ". Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data or the results to be obtained by the use thereofand all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data.

Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages including lost profits even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI's express written consent.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Predicting Stock Market Returns Using Shiller-CAPE And PB Jul. StarCapital Global Market Valuation Research. Summary Shiller-CAPE and price-to-book ratio enable reliable forecasts on subsequent stock market returns.

Long-term market potential based on findings: Traditional price-earnings ratios are unreliable Given this fact, valuation metrics such as the commonly used price-to-earnings ratio PEwhich looks at a market's corporate earnings in relation to current market prices, would not provide a reliable correlation to the next year's stock market earnings even if it were possible to make an exact forecast Figure 1.

Cyclically adjusted price-to-earnings ratio CAPE As far back asGraham and Dodd suspected that cyclical fluctuations in earnings could adversely affect the validity of PE.

Attractive CAPE indicates investment opportunities The cyclically adjusted CAPE actually permits much more reliable long-term return forecasts than the classic PE. CAPE enables international return forecasts This correlation is not exclusive to the US market. Flaws in the CAPE approach Investors need to note that the CAPE approach is based on the assumption that stock market earnings reverse to their year mean.

Price-to-book ratio PB improves return forecasts In view of the above, it seems advisable to take a look at other key figures used for making long-term return forecasts, not just CAPE. What level of stock market returns can investors expect? Which uncertainties cloud these forecasts? Scenario analysis for the German stock market The distribution of returns in the German market is far more upbeat. Conclusion Equity investment is not just the most lucrative long-term form of investment; taking inflation and liquidity into account, it is also one of the safest.

Bibliography Campbell, John, and Robert Shiller. Stocks for the Long Run. Macro ViewMarket OutlookEditors' PicksSA Submit. Want to share your opinion on this article? Disagree with this article? To report a factual error in this article, click here. Follow Norbert Keimling and get email alerts.