CAPE: Predicting Stock Market Returns
StarCapital Research Publication, February 2014
8 Pages Posted: 5 Feb 2015 Last revised: 12 Feb 2015
Date Written: February 24, 2014
Equity investments are subject to high volatility in the short to medium term and a crucial factor for the strategic return potential is the timing of new investments. The objective of this examination has been to answer the extent to which the timing of new exposures can be successfully chosen using the cyclical adjusted Shiller CAPE, and whether the indicator allows statements to be made on long-term equity market returns.
The examination reaches the conclusion that it is possible to forecast relatively reliably the long-term equity market returns of 15 equity markets using a cyclical adjusted CAPE. The concept has demonstrated impressive results in the US market over the past 130 years and in 14 other equity markets in the period 1979-2013. It is fair to assume that this connection can also be found in other markets even if we are unable to empirically verify this theory for lack of available data. Based on the insight thus gained, long-term equity market forecasts can be made for various markets for the next 15 years.
The overall conclusion that we reach is that investors who, unlike the majority of investors, do not position themselves close to the benchmark with a high US weighting can expect annual capital growth of some 6% above and beyond the inflation rate over a long term horizon. A number of European equity markets in particular, but also selected emerging markets, currently display significant undervaluations and offer strategic investors interesting opportunities for exposure.
Keywords: Shiller PE, CAPE, Asset Allocation, Stock Market Potential
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