{"id":8456,"date":"2020-01-21T15:52:44","date_gmt":"2020-01-21T15:52:44","guid":{"rendered":"https:\/\/zackspcg.com\/blog\/?p=8456"},"modified":"2022-02-26T13:06:48","modified_gmt":"2022-02-26T13:06:48","slug":"cape-ratio-says-market-is-overvaluedbut-is-it","status":"publish","type":"post","link":"https:\/\/zacksim.com\/blog\/cape-ratio-says-market-is-overvaluedbut-is-it\/","title":{"rendered":"CAPE Ratio Says Market is Overvalued\u2026But Is It?"},"content":{"rendered":"\n

The Nobel laureate economist, Robert Shiller, recently penned an article in The New York<\/em> Times <\/em>warning, amongst other things, that market valuations (as measured by the CAPE ratio) were at levels not seen since 1929 and 1999.1<\/sup> Market historians would note that 1929 and 1999 preceded weak decades for market returns, with the Great Depression on the one hand and the Tech Bubble and Great Recession on the other.<\/p>\n\n\n\n

With the start of a new decade in 2020 and the historically high CAPE ratio, it begs the question: are we in year one of a weak decade for stocks?<\/em><\/p>\n\n\n\n

First, an Understanding of How the CAPE Ratio Works<\/strong><\/p>\n\n\n\n

A good starting point for understanding the CAPE ratio is to think about the basic P\/E ratio first. The P\/E (price to earnings) ratio measures a stock\u2019s price relative to its per-share earnings over the last year. It is a widely-accepted metric for valuation, but Shiller and fellow economist John Y. Campbell saw a problem with it.<\/p>\n\n\n\n

They recognized that a company\u2019s earnings can be fairly volatile from year to year, and that earnings volatility is especially true during peak and trough years in a business cycle. So, to minimize the effect of short-term business cycle gyrations on the valuation measure, the two economists created a ratio where the stock price is divided by the company\u2019s average earnings over the previous 10 years<\/em>, instead of just a single year. This helps \u201csmooth\u201d out the number and allows for comparing valuations over a longer time horizon.<\/p>\n\n\n\n

A high CAPE ratio signals an overvalued market, and Shiller notes that the current CAPE ratio (31) has only been higher twice in history: 1929 and 1999. The S&P 500 fell some -85% through 1932 and -50% in the 2000 bear market.2<\/sup><\/p>\n\n\n\n

_____________________________________________________________________<\/p>\n\n\n\n

Does this Mean a Bear Market is Around the Corner?<\/strong><\/a>
 
The CAPE ratio is only one factor to consider. Instead of letting one indicator make you fearful of a bear market, I recommend focusing on the whole picture. In addition to the CAPE ratio, it is important to keep an eye on fundamentals, earnings, growth, innovation and other key economic indicators, in my view. To help you do this, we are offering all readers a look into our just-released February 2020 Stock Market Outlook report.

This report will provide you with our forecasts along with additional factors to consider:<\/p>\n\n\n\n