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We have already seen that the US stock market is at a historically high level as measured by the cyclically adjusted price earnings ratio, CAPE (see earlier Newsletters). It has only been higher in 1929 and 1999-2000, which is not very reassuring given the evidence that high CAPEs are usually followed by low returns over the following decade.
But what about on this side of the Atlantic? Are UK and other European CAPEs at high levels?
United Kingdom
For this Newsletter I’ll use the analysis conducted by Norbert Keimling of Star Capital. First note that the data outside of the US is for much short periods. For the European countries the CAPE valuations begin December 1979 (using data going back ten years before that) and go up to May 2015.
The average (median) CAPE for UK shares was 15.0 in that period, which is comparable with that for the USA since 1881 at 16.0, but not with that for the US since 1979 at 21.1.
Source: (“Predicting Stock Market Returns Using the Shiller CAPE” www.starcapital.de/files/publikationen/Research_2016
The negative relationship between CAPE and returns is clearer in the case of the UK than for the USA – but remember there are only 35 years of data for the UK compared with 135 for the S&P 500.
Where is the UK market now?
Norbert Keimling asks: given the past relationship across countries and the CAPE at 12.7 in December 2015, what does the model predict over the next 10-15 years?
The answer is an average annual real return on UK shares of 9.1%.
(This relationship is not based solely on UK country data but derived from “All Countries” regression of CAPE and subsequent long term returns).
Between December 2015 and end of December 2016 the All Share index rose 12% and the CAPE has moved to 14.8. This is an updated figure from Star Capital, who say that such as ratio means expected annual returns of 8% on average for the next decade or so.
In 2017 so far the FTSE All Share index is up another 3%, so the expected return based on this model is shaved a bit more.
However, the UK market is currently not far away from its long term average CAPE of 15 which would indicate relatively satisfactory returns over the long run.
Other countries
The purpose of presenting the data below is not to make pinpoint precise forecasts of how these market will perform, but to illustrate the commonality of the negative relationship between CAPE and future returns – but the Danes had to be different!
It is also to give a general impression of whether a market is currently high or low in the historical context.
Germany
Average CAPE (1979 – 2015): 17.9………………………………………………………….
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