To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller. Background information here.Chart 1 plots the Shiller PE10. Key points this month are:
Shiller PE10 = 19.9 which is down from 20.6 last month. My UK Equities target asset allocation therefore increases from 18.6% to 18.8%. Additionally my International Equities target asset allocation increases from 13.3% to 13.4%.
Shiller PE10 Average (1881 to Present) = 16.4. This means we are currently still 21% higher than the long run average since 1881.
Shiller PE10 20 Percentile (1881 to Present) = 11.0
Shiller PE10 80 Percentile (1881 to Present) = 20.6. The Shiller PE10 has now fallen back through the 80 Percentile.
Shiller PE10 Correlation with Real (ie after inflation) S&P 500 Price = 0.78
Chart 2 further reinforces why I am using this method. While the R^2 is low there appears to be a trend suggesting that the return in the following year is dependent on the Shiller PE10 value. Using the trend line with a PE10 of 19.9 results in a 1 year expected real (after inflation) earnings projection of 5.2%.
Chart 3 plots Real (after inflation) Earnings and Real Dividends for the S&P 500. Real Dividends are still falling however they are still above their long term trend. Real Earnings have a roller coaster ride continually, particularly since about 1990. If the Standard and Poors forecast earnings are to be believed however we continue to be above the long term earnings trend and climbing.
Assumptions include:
- Q4 ’09 & Q1 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. January & February ‘10 inflation is extrapolated.
- January & February ‘10 dividends are estimated as December ‘09 dividend.
- Prices are month averages except February ‘10 which is the 11 February ’10 S&P 500 stock market at 1430.
- Historic data provided from Professor Shiller website.
As always DYOR.
love the posts, keep them coming... am figuring you might be an aussie living in the UK too with the ASX200 data inclusions? You have saved me some time with PE10 calculations, so thanks!
ReplyDeleteThanks for the support. Australia is a very real potential retirement location for me and so I like to keep a close eye on it. I therefore intend to watch property values monthly from a couple of perspectives. I also invest in Australian equities as an asset class to ensure I get significant Aus market and AUD exposure.
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