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CAPE 7 vs CAPE 10

Posted: Sun Feb 18, 2018 3:06 pm
by BuyAndHoldOn
Since the Financial Crisis [potentially] skews the CAPE 10 metric, would a CAPE 7 (or 8) be useful for comparison? I am thinking of the US but this could apply to other countries as well.

I’ve seen the CAPE ratio formula somewhere; and Schiller posts his data sets - so this seems doable.
http://www.econ.yale.edu/~shiller/data/ie_data.xls

Haven’t done this yet - and wondering if this information is already published.


Edit: this site appears to do that calculation- although I can’t see what the inputs are.
https://dqydj.com/shiller-pe-cape-ratio-calculator/

7-year CAPE came up as ~30; 10-year cape is ~35.

Re: CAPE 7 vs CAPE 10

Posted: Sun Feb 18, 2018 4:38 pm
by willthrill81
CAPE 7 will lead you to roughly the same 'conclusion' as CAPE 10: the market's valuations are significantly higher than their historic average.

A big part of the problem with using valuations, however, is that they do not have a strong mean reversion tendency. CAPE (7 or 10) has been above its historic average in the U.S. almost constantly since 1992. Hence, like other valuation metrics, it is only a very crude tool used to give an estimate of future market returns with a large margin of error. How beneficial this is is a matter of opinion, but it's essentially worthless as a market timing tool.

As a means of estimating future safe withdrawal rates, however, it has been far more useful.

Re: CAPE 7 vs CAPE 10

Posted: Sun Feb 18, 2018 4:52 pm
by JBTX
I'm not sure cape7 makes more conceptual sense than cape10. Seems like it is a bit of a cherry picked scenario to avoid the downyears. Economic downturns happen typically more than every 10 years. While 2008+ was worse than normal, i would say the last 5 years or so have shown well above average earnings multiples and earnings ratios. I'm not sure how you can filter out the bad vs the good.

Bottom line, valuations are historically high. Will they eventually revert towards the mean? Probably, but we can't be sure. If so, when will it happen? It could be soon, or it could be decades.

I would say CAPE10 is probably helpful in terms of planning whether your long term return return (10-20 years plus) will be above or below average, with a fairly wide range of potential outcomes. It isn't very good at predicting if the market will crash in the next 3 years.

Re: CAPE 7 vs CAPE 10

Posted: Sun Feb 18, 2018 5:01 pm
by Kevin M
There is a recent thread about this blog post, http://www.philosophicaleconomics.com/, in which CAPE 7 is used for the reason you allude to.

Kevin

Re: CAPE 7 vs CAPE 10

Posted: Tue Feb 20, 2018 11:04 am
by getrichslowly
Recessions happen, so it makes sense that a recession should be included in the measure of average earnings. Otherwise you are overestimating earnings. If a recession happens again and earnings fall, you won't get the overestimated earnings.

The problem with CAPE10 is that if we go 3 more years without a recession, then CAPE10 will become inflated.

Re: CAPE 7 vs CAPE 10

Posted: Tue Feb 20, 2018 11:14 am
by alex_686
JBTX wrote:
Sun Feb 18, 2018 4:52 pm
I'm not sure cape7 makes more conceptual sense than cape10.
I think it is a valid thesis to explore. The point of CAPE10 is that you want a long enough period of time to smooth out one off accounting adjustments to earnings to get to the real economics earnings. There is nothing magical about 10 years or 9 or 7. You just need a long enough period to even things out but not too long for secular changes to occur.

If you are going to do this, compare and contrast with CAPE10 and forward earnings projections.