The CAPE Value Translates Emotion Into a Number – That’s Huge

“Stocks are getting pricey. I am thinking that maybe I should take a little off the table.” That’s the sort of statement that an intelligent investor might have made in pre-Shiller days. If you hadn’t been exposed to Buy-and-Hold (which has only been around since the 1960s), you didn’t need Shiller to tell you that valuations matter. That’s common sense. But knowing that valuations matter is not terribly helpful in a practical sense. What are you supposed to do about it? That’s the important question.

Saying that “valuations matter” and not offering more specific guidance is like saying “drive safely.” Sure, you should drive safely. But there’s more value in advice to stay under the speed limit or not to drive when you are feeling sleepy or not to drive when you have been drinking or to be sure to check the air pressure in your tires from time to time.

Shiller did two important things. One, he discredited Buy-and-Hold. The “idea” that m arket timing is not always 100 percent required for all investors was a terrible mistake. Shiller showed that it’s not so. That one merited a Nobel prize. Easy.

Advertisement

But Shiller did something else of even greater importance. He popularized the idea of using the CAPE value (the cyclically adjusted price earnings ratio) as one’s measure of the extent of overvaluation present in the market at a given time. The CAPE does a much better job than the old PE ratio (price-earnings ratio). And we need as good a measure as possible to engage in market timing in an effective way.

Looking for something better than CAPE value

Stop! The CAPE value may not be perfect. It may be that, after we have opened every site to honest posting, we will develop even better valuation assessment tools. If we do, that’s great. The reason why I am constantly saying that we need to open every site to honest posting is that it is through discussions amongst ourselves that we discover and develop better strategies and better tools. So by all means we should be on the look-out for something better than CAPE. But CAPE is a big advance. Investors should be making far more use of it than most make of it today.

When was the last time that you heard someone in this field refer to CAPE? It is a rare event. I believe that we should be talking about CAPE every single day at every single place. Engaging in market timing is 70 percent of what it takes to achieve long-term investing success. CAPE is the thing that makes effective market timing possible. CAPE is the stock investor’s best friend.

Today’s CAPE is 30. The fair-value CAPE is 17. So stocks are priced at not quite but almost two times their fair value. If you wanted to keep things simple, you could just divide the number supplied on your portfolio statement by two to identify the true and lasting value of your stock holdings. It’s important to know where you stand. You also need to know what the going-forward return on stocks is going to be to set your stock allocation. The Stock-Return Predictor reveals that to those who know the right CAPE value to plug in.

We’re all emotional. For good or for ill, that’s the way it is with us humans. In pre-Shiller days, there wasn’t much that we could do about it. We could get anxious at times of high stock prices. But what good does getting anxious do? Today, we can react to the high stock prices. We can pull together as a nation of people and get that CAPE value down to a more reasonable level. And we can protect our personal retirement account by getting our stock allocation down to what is appropriate for a time when the stock market is as emotional as it is today.

Investor emotion is nothing new. It’s been there since the first stock market opened for business. And it has been wreaking havoc on investors for all that time. No more. Now we know what to do about it and possess the tools to keep investor emotion from hurting us anymore. We’re the world’s first truly valuation-informed investors.

It’s a big deal. Stocks no longer need to be as risky as they have always been throughout history.

Rob’s bio is here.

Advertisement

Comments are closed.