King of the Mountain: Shiller P/E and Macroeconomic Conditions

Posted: 7 Aug 2015

See all articles by Robert D. Arnott

Robert D. Arnott

Research Affiliates, LLC

Denis B. Chaves

The Capital Group Companies

Tzee-man Chow

Research Affiliates, LLC

Date Written: August 5, 2015

Abstract

Contrary to naïve expectations, we find that moderate rather than rock-bottom levels of inflation and real interest rates are associated with lofty valuation multiples. Moderate levels create a valuation “mountain,” which is evident not only in the U.S. stock market but in the stock markets of other developed countries. In addition to confirming the evidence presented by Leibowitz and Bova (2007) that P/Es tend to fall in times of both unusually low and high real interest rates, our work suggests a similar linkage between P/Es and inflation. We also study the mean-reversion properties of Shiller P/Es conditioned on real yields and inflation rates. If we assume that P/Es revert toward the levels thus suggested by macroeconomic conditions, we achieve far better forecasts of both long-term and short-term market returns than if we assume reversion toward the long-term historical mean. Our findings suggest new and interesting insights for monetary policy as well as valuation models.

Keywords: inflation,real interest rates,shiller P/E

Suggested Citation

Arnott, Robert D. and Chaves, Denis Biangolino and Chow, Tzee-man, King of the Mountain: Shiller P/E and Macroeconomic Conditions (August 5, 2015). https://doi.org/10.3905/jpm.2017.44.1.055, Available at SSRN: https://ssrn.com/abstract=2640327 or http://dx.doi.org/10.2139/ssrn.2640327

Robert D. Arnott (Contact Author)

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Denis Biangolino Chaves

The Capital Group Companies ( email )

333 S. Hope Street, 53rd Floor
Los Angeles, CA 90071
United States

Tzee-man Chow

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States
949-325-8754 (Phone)

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