CHART OF THE DAY: The Famous Shiller PE Ratio Is Predicting Positive Returns

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The Shiller P/E ratio, or the cyclically-adjusted price-earnings ratio, is one of the most popular measures of stock market value.

It’s calculated by taking the S&P 500 and dividing it by the average of 10 years worth of earnings.  If the ratio is above the long-term average of around 15, the stock market is considered expensive.

Today, the Shiller P/E is at 22.6.

But that’s not to say you can’t generate a positive return if the Shiller P/E is above 15.

“We believe the concern for many investors is that equities are expensive in absolute terms: this is true – but has not necessarily led to negative returns,” wrote Credit Suisse’s Andrew Garthwaite in a new note to clients.

“Equities have typically only suffered negative real returns over a given five-year period when the Shiller P/E at the beginning of the period was above 26x (and clearly good real returns when the Shiller P/E had fallen below 13x). In fact, when markets were trading on current Shiller P/Es in the past, the subsequent average annualised five- year real return was slightly below 5%, compared to a current real bond yield in the US of minus 0.5%.”

Garthwaite charted the historical annualized 5-year returns based on certain levels of the Shiller P/E.

Shiller PE

Photo: Credit Suisse

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