Shiller's Excess CAPE Yield

[Daithi7]

Stocktake: Just how expensive are US stocks?

Take low interest rates into account and the valuations start to look more reasonable

www.irishtimes.com

Interesting piece here in the Irish Times, weighing up how expensive stock market fundamentals are relatively using the Robert Shiller's measure of Excess CAPE Yield ( ~CAPE yield less interest rates).

"....
Adjusting for rates certainly changes things, says Liberum strategist Joachim Klement. His calculations suggest that compared to the last 15 years, US valuations are “on the border between fair and expensive” if you adjust for low rates.

So all clear for US stocks? Well, no. The same methodology gives an adjusted price-earnings ratio of 13.8 for Europe and 11 for the UK, compared to 24.7 for the S&P 500....."

What do people think of Excess CAPE Yield as a good measure of a specific market's overall investment attractiveness?
( Relative to historical averages in that market index??
And say, Relative to other markets???)

 

[Daithi7]

A few other articles & links on Robert Shiller's Excess CAPE Yields fyi:

Here's why Robert Shiller's two stock-market indexes are telling wildly different valuation stories.

The Nobel laureate has two ways to measure stock-market valuation -- and each tells its own story about whether stocks are in a bubble.

www.marketwatch.com

Shiller’s New Metric Suggests Opportunity Lies Overseas

Many investors use Robert Shiller's market indicators like his new Excess CAPE Yield (ECY) when determining what market sectors to buy into.

moneyandmarkets.com

Chart of the Week: Valuations and returns - a (less) cautionary tale | Lipper Alpha Insight | LSEG

The cyclically adjusted price-to-earnings ratio (CAPE) for the S&P 500 is often used to illustrate the excessive valuations of equities, especially recently. However, CAPE does not control for the increasing

lipperalpha.refinitiv.com

 

[cremeegg]

My understanding of this Excess CAPE is that it measures by how much the earnings yield exceeds the return on 10 year bonds over inflation.

Earnings yield 3%, 10 year bonds yield 1%, Inflation 2%. So the Excess CAPE is 3 - (1% - 2%) i.e. 4%. Numbers roughly current just to create an example.

The actual Excess CAPE at present is about 3%, from the 3rd link above

I understand this to mean that while stocks are expensive, they are not very expensive given that interest rates are so low.

It seems to me that there is nothing in this that Benjamin Graham would not recognise, except rather than talk about the Excess CAPE he would say the discount rate is low and this supports high valuations for stocks.

I think he might go on to wonder what will happen if (when) the discount rate were to rise.

Actually that is mathematically an easy question.

Let us assume that the correct discount rate at present is 2% and a given stock is priced at €100. All else being equal if the discount rate rises to 3% that stock will fall to €66.66

 

[Daithi7]

My understanding of this Excess CAPE is that it measures by how much the earnings yield exceeds the return on 10 year bonds over inflation.

Earnings yield 3%, 10 year bonds yield 1%, Inflation 2%. So the Excess CAPE is 3 - (1% - 2%) i.e. 4%. Numbers roughly current just to create an example.

The actual Excess CAPE at present is about 3%, from the 3rd link above

I understand this to mean that while stocks are expensive, they are not very expensive given that interest rates are so low.

It seems to me that there is nothing in this that Benjamin Graham would not recognise, except rather than talk about the Excess CAPE he would say the discount rate is low and this supports high valuations for stocks.

I think he might go on to wonder what will happen if (when) the discount rate were to rise.

Actually that is mathematically an easy question.

Let us assume that the correct discount rate at present is 2% and a given stock is priced at €100. All else being equal if the discount rate rises to 3% that stock will fall to €66.66

And this is exactly what is happening. Interest rates are now rising, central banks were slow to react to controlling inflation, which is their predominant priority in helping manage money supply. This happened imho because of the very understandable reason of being in the midst of a global pandemic. That has subsided now, but inflation hasn't, and central banks must react. So the forward discount rate has gone up, the Excess Cape Yield is getting trounced and equities are in for a period of revaluation to reflect this reality.

Further QE is being withdrawn and earnings are coming off peak levels, so there is a big downturn coming in equity prices imho. It would be a good exercise to measure the ECY for some different scenarios going for forward , that should give the rules of thumb for this next investing cycle imho.

P.s. and markets will likely overreact on the downside. So value should be attainable later in this cycle