I ask this having just read some comments from JP Morgan Asset Management, who acknowledge that the S&P does look pricey when compared to the broad sweep of history. According to Chief Global Strategist Andrew Goldberg:
"Shiller's CAPE has crossed into the top tenth of historical observations since 1881. On average, this level of valuation has led to negative annualized returns over 5-year investment horizons."
However, Mr Goldberg questions the validity of setting today’s valuations alongside those in the dim and distant past.
“Comparing data from the late 19th century and early 20th century to today’s economy may not be relevant given globalization and the changing composition of the U.S. market. Shortening the comparison to the last 50 years of data, which may serve as a better comparison for today’s modern economy, suggests only a slightly expensive market with low to moderate returns going forward on average.”
Using data from the last half century only, JP Morgan Asset Management find that today’s CAPE of 25 is consistent with nominal annualised price returns on a five-year view of somewhere over 5%. Tack on the dividend yield and the outlook brightens up even more.
Clearly, the main risk of taking this approach is that of brushing inconvenient facts under the rug. My gut-instinct would be to use as much of the data as possible. But Mr Goldberg certainly has a point about the need for caution when comparing today’s US economy with that of a hundred years ago or more. This is especially true when much of the data involved is an academic recreation, rather than what was known at the time.
Assuming that the last half century is indeed the most relevant period, we have two possible scenarios to draw upon in which the market keeps getting dearer from here.
The first is where CAPE soars into the stratosphere, as it did from the middle 1990s into the millennium. For all the froth in technology and biotech of late, I find that unlikely, although another massive slug of Quantitative Easing could yet prove me wrong.
The second is a mid-2000s scenario in which CAPE scrapes along at high levels for a few years. This is consistent with modest gains in the S&P of the type Mr Goldberg highlights. I find this version of events less implausible, although still less likely than the bumpy ride I describe in this recent note: http://bit.ly/OUlKw6
Of course, if the low to modest gains in the S&P mooted by JP Morgan play out, it would probably be great news for the FTSE 100. The FTSE 100 is much more attractively valued on a seven-year view than the S&P 500, as I discuss in this note http://bit.ly/1o0oKXh. Should the US achieve low gains over the next few years, rather than losses, the UK might well realise the potential returns I believe are implied by its current valuation.
You can watch my interview with Andrew Goldberg from late last year here: http://bit.ly/1a5Lz3C