Does Jeremy Siegel Trust the Shiller P/E?

Does Jeremy Siegel Trust the Shiller P/E?

August 23, 2013 Uncategorized, Macroeconomics Research
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(Last Updated On: August 26, 2013)

In early August, Wharton finance professor Jeremy Siegel went on CNBC’s “Futures Now” and announced, “my target [for the DOW] is 16,000 to 17,000 for the end of this year…and I think 18,000 is definitely achievable in 2014.”

Siegel continued, “the market is totally spooked by whether QE continues or not,” but the Fed “would never accelerate tapering unless the economy was so much stronger, which has got to be good for earnings. So in one way, you can’t lose on stocks—either the economy’s weak, the tapering will end; or the economy’s strong, they’ll taper, and earnings will be strong. That’s why I think stocks are still a win-win situation.”

It’s pretty clear that Siegel is currently bullish, but predicting the stock market is an especially tricky proposition, so we took note when last Monday, August 19, Siegel took another swipe at the bears when he published an opinion piece in the Financial Times entitled “Don’t put faith in CAPE crusaders,” in which he argues that the high current Shiller P/E (also known as the cyclically adjusted P/E or “CAPE”) offers a distorted measure of stock market valuation due to a downward bias in earnings caused by accounting changes.  As Siegel put it in the piece:

“The Cape ratio has been a powerful predictor of long-term equity returns, forecasting strong returns in the early 1980s and poor returns from the market peak in 2000. But for many years its predictions have been very bearish. In fact, in all but nine months in the past 22 years the Cape ratio has been above its long-term average, and the ratio currently predicts well below-average stock returns.

I believe the Cape ratio’s overly pessimistic predictions are based on biased earnings data. Changes in the accounting standards in the 1990s forced companies to charge large write-offs when assets they hold fall in price, but when assets rise in price they do not boost earnings unless the asset is sold. This change in earnings patterns is evident when comparing the cyclical behaviour of Standard and Poor’s earnings series with the after-tax profit series published in the National Income and Product Accounts (NIPA).

For the 2001-02 and 2007-09 recessions, S&P reported earnings dropped precipitously due to a few companies with huge write-offs, while NIPA earnings were more stable. Yet before 2000, the cyclical behaviour of the two series was similar. Downward biased S&P earnings send average 10-year earnings down and bias the Cape ratio upward. In fact, when NIPA profits are substituted for S&P reported earnings in the Cape model, the current market shows no overvaluation.”

Meb Faber over at Cambria Investments responded on his blog yesterday, arguing that even this “earnings bias” idea is true, and we add back the effect of those writedowns, the market is still expensive:

http://www.mebanefaber.com/2013/08/22/what-siegel-is-missing/

Last year, Cliff Asness, founder of AQR Capital Management, published a compelling white paper on CAPE entitled, “An Old Friend: The Stock Market’s Shiller P/E,” in which he had the following to say to those who would use historical accounting changes, or other “this time is different” –type arguments as a basis for objecting to the Shiller P/E:

“…some critics say you can’t compare today to the past because accounting standards have changed, and the long-term past contains things like World Wars and Depressions. While I don’t buy it, this argument applies equally to the one-year P/E which many are still somehow willing to use. Also it’s ironic that the chief argument of the critics…is that the last 10 years are just too disastrous to be meaningful…Does it seem to anyone else but me that the critics have a reason to exclude everything that might make one say stocks are expensive, and instead pick time periods for comparisons and methods of measurement that will always (adapting on the fly) say stocks are fair or cheap?”

So what do our readers think?  Is it reasonable to argue that Siegel is simply saying “this time is different,” when he says the Shiller P/E is flawed at this particular point in time? We will be interested to see whether Siegel’s bullish projections are borne out.

If you are looking for some additional background, below are a few of our observations on the Shiller P/E and the subject of predicting stock market returns:


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

David Foulke

Mr. Foulke is currently an owner/manager at Tradingfront, Inc., a white-label robo advisor platform. Previously he was a Managing Member of Alpha Architect, a quantitative asset manager. Prior to joining Alpha Architect, he was a Senior Vice President at Pardee Resources Company, a manager of natural resource assets, including investments in mineral rights, timber and renewables. He has also worked in investment banking and capital markets roles within the financial services industry, including at Houlihan Lokey, GE Capital, and Burnham Financial. He also founded two technology companies: E-lingo.com, an internet-based provider of automated translation services, and Stonelocator.com, an online wholesaler of stone and tile. Mr. Foulke received an M.B.A. from The Wharton School of the University of Pennsylvania, and an A.B. from Dartmouth College.


  • Garrett

    Seems like for the CAPE to make sense you would need to apply and average ROD to the market’s current shareholder’s equity to get normalized earnings. Just using average earnings discounts past growth, which is silly.

  • mark

    What does Dr Gray think on the Shiller CAPE?

  • I think it is a useful 40,000′ metric. That said, we tried to look at the Shiller P/E as a practical timing tool and it wasn’t too exciting:
    https://www.dropbox.com/s/j7ch635u095tpfv/TAA_duringcheap_v01.pdf