CAPE Around the World Update 2015 – Return Differences and Exchange Rate Movements

Abstract

We update our annual analysis of expected returns for 38 equity markets around the world. For the first time since we started our series in 2012, we find most emerging markets now exhibit higher expected returns than developed markets. In particular the expected returns for the core European stock markets of Germany, the UK and Switzerland have declined after strong performances of 2014 and early 2015. For many of these markets, expected returns are now at or below historical averages, but still significantly above the mediocre returns expected for the US stock market.

In this study we examine the significant differences between expected returns in different countries. We demonstrate that exchange rate movements exert a considerable influence on stock market returns. Contrary to common belief, exchange rate movements also matter for longer investment horizons of, say, five to ten years. We show how stock market valuation differences correlate with exchange rate movements, and perhaps surprisingly we show that CAPE differences between two countries offer some insight into their long-term exchange rate trends. One likely outcome of our analysis is that over the next five years European stock markets will likely show higher returns in euros than do US markets in dollars. We would quickly add that exchange rate movements may reduce the effective return difference when calculated in a common currency such as the euro or the dollar. Thus, to reap the full benefits of a global equity investment strategy, US investors should use currency-hedged investments to avoid losses from devalued foreign currencies.

Keywords: Shiller PE, cyclically adjusted PE, equity market returns, currency risk

JEL Classification: G12