Beware the Cyclically Adjusted P/E

Henry Blodget points out that the stock market is 30% overvalued according to the Cyclically-Adjusted P/E Ratio (CAPE) which looks at the inflation-adjusted earnings of the last ten years.

I’m very leery of the CAPE because the stock market is itself cyclical so there’s no need to adjust for it. Also, a ten-year window is too long to consider. For example, the CAPE maybe high now but it will probably fall very soon due to very favorable comparisons.

Earnings peaked in September 2000 and hit a bottom in March 2002. This means that those lower earnings numbers will come off the CAPE while higher earnings will be added on. This will appear as an earnings growth upward revamp when in fact, all we have done is ditch the depressed earnings from ten years ago. As a result, the CAPE may soon tell us that the market is fairly valued.

Posted by on November 15th, 2010 at 1:40 pm


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