Shiller Peak Analysis


-1.9% implied return.

When looking at the Shiller PE ratio to see its influence on stock prices, there are two big questions:

  1.  Do periods of low earnings artificially inflate the PE ratio?
  2. Has the economy fundamentally shifted in the last 100 years in such a way that we cannot expect the same average PE ratio for equity investments?

29.8 is high.  Only two times has it been higher – the stock market crash in 1929 (32.6), and the Internet bubble in 2000 (44.2).  The PE ratio overall seems to have a slow upward trend over the last 100 years, but nothing to justify 29.8.  It reached 27.4 before the 2008 housing crash.  23.7 before the horrible decade of the 1970s.

March 1, 2009, it dropped to 13.3.  That is almost exactly the day I submitted my offer on the hugely profitable condo.  This was also the low of the stock market.  I don’t hope that the PE ratio drops down to 13 again, but it doesn’t seem outside the realm of possibility.  Looking at the last 20 years, it seems that buying under anything less than 20 was pretty damn profitable.  What’s the probability that the PE ratio will now never drop below 20?  There doesn’t seem to be any reason for that.  One strategy would be to sell my stocks and only buy once things get below 20 after a crash.

Now, keep in mind, Black Monday was a local PE peak, but it was still a great time to invest, as long as you sold before 2000.  So it seems like the character of these large peaks and crashes dominates the outcome.  Are we heading into a Stone Mountain or an Everest?


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