Capitol Report: Elevated CAPE ratio suggests stock market returns to decline, regional Fed bank finds

What goes up…

A popular measure of valuing stocks looks set for a decline, and stock returns will suffer because of it, according to new research published Monday by the Federal Reserve Bank of San Francisco.

The cyclically-adjusted price-to-earnings, or CAPE, ratio is the inflation-adjusted value of the S&P 500 index SPX, +0.16%  divided by the real earnings of companies in the index averaged over the most recent 10 years.

Going back to 1881, big run-ups in the CAPE ratio—usually from the advent of new technologies including high-speed rail, automobiles and the internet—were met with substantial decline in stock prices.

The quarterly average CAPE ratio stands at around 30, exceeded only by the peak values of 43 in 2000 and 31 in 1929, according to a paper from San Francisco Fed research adviser Kevin Lansing.

Lansing compared the CAPE ratio against different economic variables to determine whether it’s signaling that stocks are overvalued. So far, the answer isn’t really—the actual CAPE ratio is about 8% above where a regression model that includes the natural rate of interest, potential GDP and core inflation suggests it should be. It was 40% above the fitted ratio in early 2000, at the peak of the internet bubble.

But the projected path of that model implies a 13% decline in the CAPE ratio over the next 10 years.

“All else being equal, stock returns in this case would be lower than those observed since 2009 when the CAPE ratio was doubling. Investors who expect high stock returns in the coming years based on recent market experience may end up being disappointed,” he wrote.

Filed in: Top News Tags: 

You might like:

America owes millennials an apology — everyone blows their budgets eating out America owes millennials an apology — everyone blows their budgets eating out
The Wall Street Journal: Anbang Insurance Group taken over by Chinese regulators The Wall Street Journal: Anbang Insurance Group taken over by Chinese regulators
Where you sit at the office could influence your next promotion Where you sit at the office could influence your next promotion
NRA backlash: Major bank and car-rental giant are ending partnerships NRA backlash: Major bank and car-rental giant are ending partnerships
Asia Markets: Asian stocks jump to early gains after Dow’s rebound Asia Markets: Asian stocks jump to early gains after Dow’s rebound
What’s better for you: a low-fat or low-carb diet? Scientists have an answer What’s better for you: a low-fat or low-carb diet? Scientists have an answer
The New York Post: Did a Kylie Jenner tweet really prompt Snap shares to tumble? The New York Post: Did a Kylie Jenner tweet really prompt Snap shares to tumble?
MarketWatch First Take: HP Enterprise earnings jolt stock, but there isn’t much to be excited about MarketWatch First Take: HP Enterprise earnings jolt stock, but there isn’t much to be excited about

Leave a Reply

Submit Comment
© 8162 Stock Investors News. All rights reserved. XHTML / CSS Valid.