Today I have been looking at Robert Shiller's CAPE dataset. For those who haven't heard of this series before, the prominent Yale economist created this extensive dataset (spanning back to 1871) for his book, Irrational Exuberance. The dataset includes: S&P 500 index values, earnings, dividends, long-term interest rates, and more. However, the most interesting contribution is his cyclically adjusted price-to-earnings (CAPE) data. The theory behind it is that given that business cycles on average last 7-8 years or more, Shiller decided to smooth earnings over a 10 year period to cyclically adjust the P/E ratio.
As a predominantly value-oriented investor, my main interest is to look at the impact of the CAPE on the annually compounded returns for the following 10 years. Intuitively, we expect to witness a negative relationship between the CAPE and future returns, as reported by Shiller. Of course, this is the case.
However, in an effort to clarify the impact of 'value' (lower CAPE) on returns, I have broken down the 142 year dataset into shorter sub-periods and plotted their relationship, allowing for an interesting portrayal of how this value relationship has changed over time. Please see below the links to the resultant dataset and IPython notebook.
As you can see from the plots, the results are very interesting. It appears that the expected negative relationship is non-existent between 1881 and 1911, whilst over time it transforms into a clear negative and somewhat linear relationship. I believe that the 1881-1911 results are the least revealing since the data in that period experienced the most amount of transformations and hence is less accurate (S&P 500 took over from S&P 90 in 1957), plus the fact that the propensity for markets to correct price inefficiencies was far lower than in later years. Between 1987 and 2002 the plots show a very revealing depiction of how important 'starting conditions' are to an investors pursuit of generating returns. Investing when the CAPE is over 20 seriously hinders an investors chances of high returns, whilst investing when the CAPE is over 40 virtually ensures you will experience negative annualised returns over the following 10 years.
Resultant dataset.
Ipython Notebook
As a predominantly value-oriented investor, my main interest is to look at the impact of the CAPE on the annually compounded returns for the following 10 years. Intuitively, we expect to witness a negative relationship between the CAPE and future returns, as reported by Shiller. Of course, this is the case.However, in an effort to clarify the impact of 'value' (lower CAPE) on returns, I have broken down the 142 year dataset into shorter sub-periods and plotted their relationship, allowing for an interesting portrayal of how this value relationship has changed over time. Please see below the links to the resultant dataset and IPython notebook.
As you can see from the plots, the results are very interesting. It appears that the expected negative relationship is non-existent between 1881 and 1911, whilst over time it transforms into a clear negative and somewhat linear relationship. I believe that the 1881-1911 results are the least revealing since the data in that period experienced the most amount of transformations and hence is less accurate (S&P 500 took over from S&P 90 in 1957), plus the fact that the propensity for markets to correct price inefficiencies was far lower than in later years. Between 1987 and 2002 the plots show a very revealing depiction of how important 'starting conditions' are to an investors pursuit of generating returns. Investing when the CAPE is over 20 seriously hinders an investors chances of high returns, whilst investing when the CAPE is over 40 virtually ensures you will experience negative annualised returns over the following 10 years.
Resultant dataset.
Ipython Notebook
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