Stormbringer wrote: ↑
Thu May 16, 2019 8:01 am
My hypothesis as to why CAPE has underestimated returns comes down to one thing: interest rates.
Rates have been falling for decades, and especially since 2008-2009. That has put sustained upward pressure on asset prices that CAPE does not adjust for.
There's all kind of good reasons. Legitimate solid reasons. Reasons I agree with and do not contest.
My issue is when people won't even admit that CAPE has underestimated returns in the U.S. People still actually say "CAPE has been a strong predictor of returns."
Mebane's Faber's book blurb says this.
Over 70 years ago, Benjamin Graham and David Dodd proposed valuing stocks with earnings smoothed across multiple years. Robert Shiller later popularized this method with his version of the cyclically adjusted price-to-earnings (CAPE) ratio in the late 1990s and correctly issued a timely warning of poor stock returns to follow in the coming years.
This is misleading.
Shiller predicted on July 21, 1996 that we would likely see 0% real returns over the next 10 years. This was the correct call based on the previous 100 years data. CAPE had hit 25 in 1996, which was ridiculously high at the time (Now CAPE of 25 is just considered "moderately elevated" - CAPE proponents keep changing the model, which is fine with new data, but they pretend today's model was the same back in 1996)
July 1996-2006 returns were actually 8.5% nominal (so 6.5% real?), very close to historical norms.
Even looking at periods ending in bear market years
July 1996-2002 returns were 6% nominal (so 4% real)
July 1996-2009 returns were 5% nominal (so 3% real)
Now, you can make a case that the last two are within the margin of error, but even the worst ending points weren't that terrible. All other ending points have higher returns.
July 1996-2016 returns were back to 8.5% nominal.
1996 had the second highest valuations in U.S. history. CAPE hadn't been that high for 70 years, not since the Great Depression.
And it was a pretty good time to buy stocks. At no point did a 1996 stock investor ever lose money, not even temporarily.
I find it hard to believe that someone can say that 0% real return call in 1996 was "correct and timely". It's one of the calls I point out to show how CAPE predictions haven't worked well. And here's Faber using it to prove that CAPE predictions work.
Edit: I downloaded the book (it's a pretty decent little book - only 82 pages), and I'm reading it at lunch.
Turns out he's talking about Shiller's predictions in 1998 and 1999, not the original 1996 prediction.
Funny enough, Faber quotes Fama in the introduction as a counterpoint to himself.
I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them.
I feel like this is exactly what Faber has done. He's anointed Shiller for his 1999 predictions, but ignored his 1996 predictions.
Book isn't bad.. it does makes the mistake of looking at the past from today's point of view. For instance, 25 CAPE isn't consider super high anymore.
But it was considered super high at the time. And that's important.