Gavekal Capital: What Does the Shiller PE Ratio Say About Future Returns?

Tuesday, November 19, 2013

What Does the Shiller PE Ratio Say About Future Returns?

The Shiller PE ratio has been getting a good bit of play in the financial press recently so we thought we'd give an update on where things stand. The Shiller PE hit 25.4 yesterday as the S&P 500 briefly eclipsed 1800 on an intraday basis. This PE ratio has coincided with average annualized price returns of 1.6% over the subsequent 10 year period when considering all market regimes.

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When just looking at periods when the stock market is in a structural bear market, the average annualized price return drops in half to just .7% over the next 10 years.

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In this environment dividends and the reinvestment of those dividends account for the vast majority of total returns.

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And for illustrative purposes, below is a scatter plot of subsequent 10 year returns and the Shiller Earnings Yield (1/PE), which while not perfect shows a good historical relationship between cyclically adjusted valuations and nominal returns.

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