HOW EXPENSIVE ARE EQUITIES AT THE MOMENT?
MANY INVESTORS LIKE to use Robert Schiller’s cyclically-adjusted price-to-earnings (CAPE) ratio to gauge whether a market is cheap or expensive.
It is the share price divided by the average of 10-20 years of earnings which in theory should help smooth out the impact of peaks and troughs in the business cycle.
Unfortunately this ratio may not be entirely suitable to assess whether the market has got ahead of itself.
Phillip Hoffman, investment director of Pzena Investments says the CAPE ratio has definitely been screaming over-valued for some time. However, he makes the point the Schiller’s original work was only ever meant as an indicator of long term returns for the market. ‘I don’t think it was ever meant to be a short-term market timing tool,’ he comments.
Duncan Lamont, head of research and analytics at Schroders, last year said when the Shiller PE was high, subsequent long term returns were typically poor. ‘One drawback is that it is a dreadful predictor of turning points in markets. The US has been expensively valued on this basis for many
years but that has not been any hindrance to it becoming ever more expensive.’
Perhaps a better way to gauge the market’s valuation is to look at forward PE ratios, namely how current share price match against earnings forecasts for the next one and two years.
The FTSE 100 is currently trading on 14.09 times the current financial year’s earnings estimates versus an approximate average of 13-times over the past 15 years.
In comparison, the S&P 500 in the US currently trades on 17.01-times versus a historical average of 15-times.