American markets: Cyclically adjusted price earnings ratio

I’m going to try and gather my thoughts on the US financial markets over the next few weeks (meaning occasional posts). It is possible that we are coming up to one of those big turning points, so I want to build up my knowledge and preparedness by searching for useful facts.

I’ll start with a measure considered valuable in judging the costliness of the average share in a market.

The US cyclically adjusted price earnings ratio, CAPE

The most commonly used CAPE is based on averaging the last ten years of earnings per share, and comparing that with the current share price (usually past earnings are adjusted for inflation)

It is sometimes referred to as the Shiller CAPE or Shiller P/E, or P/E 10 ratio (Shiller, of Yale University, shared the Nobel prize in 2013 for his work in the empirical analysis of asset prices).

It was in use long before Shiller presented robust empirical evidence and popularised it; in the 1930s Benjamin Graham and David Dodd pointed out the utility of viewing the market this way. So it also called Graham and Dodd’s P/E.

The chart below shows the remarkable changes over time in the multiple of 10-year average earnings Mr Market is willing to pay for S&P500 shares (the largest 500 US shares).

The 10-year cyclically adjusted price earnings, CAPE, ratio for US shares 1879 – 2016……….

 

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