The Intriguing Case of Robert Shiller’s CAPE Ratio
Robert Shiller’s cyclically adjusted price-to-earnings ratio (CAPE) is hitting levels unseen since early in the 20th century. Should this be a cause for concern? Let’s delve into the data to find out.
Understanding CAPE’s Role
While CAPE has historically been a harbinger of equity market returns, it’s not a foolproof market-timing tool. The cyclical nature of CAPE can shed light on why this might be the case.
Making Sense of the Trends
A closer look at the historical trends of CAPE reveals interesting patterns. Figure 1 showcases the fluctuating nature of CAPE over the years, hinting at a cycle of highs and lows.
Figure 2 further underscores the negative correlation between initial CAPE values and future equity market returns. This correlation can offer insights into potential market movements over the next decade.
Unraveling the Mystery
The million-dollar question is whether the current scenario mirrors past trends, or are we on the brink of a new era for CAPE? A deep dive into the time-series analysis can provide valuable clues.
The Breakthrough Analysis
By employing the Quandt Likelihood Ratio test spanning the 1980-1999 period, intriguing patterns emerge in CAPE’s dynamics. The statistical models pinpoint August 1991 as a pivotal moment in CAPE’s evolution.
Subsequent tests reveal a shift in CAPE’s mean reversion behavior post-1991, posing new challenges for market prognosticators. The implications of these findings could have far-reaching consequences on investment strategies.
Looking Ahead
As we navigate the uncharted waters of CAPE’s evolution, it’s crucial to adapt our investment strategies to the changing landscape. The past may no longer be a reliable predictor of future market movements.
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Disclaimer: The views expressed in this article are solely those of the author and do not constitute investment advice. Readers are advised to exercise caution and consult a financial advisor before making any investment decisions.