Forecasting Equity Returns Using the CAPE Ratio

Introduction Following a strong year for benchmark indices in 2021, we think speculation and inflation are two key narratives, amongst many, that may impact markets in 2022. Prof. Shiller views the current environment as being somewhat like the Roaring Twenties in which, on the tail end of the 1918-1919 Spanish Influenza pandemic, there were frenetic celebrations, spending sprees, and a “carnival of extravagance unheard of in history” – and yet ultimately, a U.S. stock market priced at its lowest level in history by December 1920.

The stock market during most of the Roaring Twenties was the biggest bull stock market in US history when you factor in inflation. Prof. Shiller calculates that the real total return for the Standard & Poor’s Composite Index (an S&P 500 predecessor), including dividends, from September 1919 to September 1929, averaged 20% a year. That implies a sixfold increase in real value over the decade. At the end, however, the index dropped 77% from September 1929 to June 1932.

Today, the annualized returns for the S&P Price Return Index are 14% over the last decade. Not as spectacular but certainly solid, and we are seeing strong parallels between the Roaring Twenties and the environment today. In the 1920s there was a sharp rise in trades by inexperienced retail investors, a surge in technological innovation and new mass media. The world entered homes electronically with radio, giving people an immediate sense of the possibility of new technologies and access to a global narrative about financial success. This is not dissimilar today as we gingerly enter a post-COVID world filled with latest technologies such as crypto coins, artificial intelligence, NFTs and the metaverse. 

Continue Reading
https://s3.amazonaws.com/bca2.0/ANX21404-Shiller-Quarterly-Market-Forecast.pdf