If you’re something a geek, you may spend may spend just as much time as me reading academic papers and research about markets and valuations.
And you may find one paper about the market and valuations quite valuable.
Win Antoon, the head of asset management at Bank Nagelmackers in Brussels and a member of the Brandes Institute Advisory Board, wrote the paper. The Brandes Institute is a research firm associated with legendary value investor Charles Brandes, and they publish some cutting-edge research on a pretty regular basis.
The paper was titled The CAPE ratio, and Future Returns: A Note on Market Timing, and it covered the use of the 10-year average PE ratio as defined by Nobel Prize-winning Yale Professor Robert Schiller. Professor Schilling uses a definition of earnings that are adjusted for inflation, and this gives us a much clearer view of the markets current valuation.
Not surprisingly, the study found that when the CAPE ratio is low, future stock market returns tend to be higher than average. When the ratio is very high, future stock returns tend to be awful. This has been studied by numerous academics and investment managers who determined it a fairly accurate measure of what we can expect from stock prices over the long term.
The ratio is currently at 29, which is well above the historical average of 16.7. So we can expect that future stock market returns will be lower than the historical average, and Antoon’s study tells us that future returns will be somewhere between bad and abysmal.
But you can’t just assume that a high CAPE ratio means that stock prices will immediately fall. The problem we face as investors are that the path to lower returns is not necessarily straight down, and there are actually many paths to lower returns.