This is another in my “Resource Roundup” series, highlighting some resources that I hope you will find useful. Today, we are going to beautiful Newport Beach, California and across the pond to Deutschland to explore some CAPE-tastic things.
Research Affiliates Webcast
I previously discussed a great resource on the Research Affiliates website: the “Asset Allocation Interactive” tool. Among the many features provided is access to the current Cyclically Adjusted Price Earnings (“CAPE”) ratio. The display also allows one to places the CAPE within the range of historical experience. In this post, I wanted to share a recent webcast presentation given by Research Affiliates discussing the CAPE.
For those who do not know what the CAPE is or why one might care where it is relative to historical experience…you should probably index. Just kidding. Although, that is a very valid option and one I employ for most of my funds. But if you’re interested in learning some basics about the CAPE (and the man who won the Nobel for his research related to it), you should probably start with Irrational Exuberance: Revised and Expanded Third Edition.
For those already familiar with the CAPE, Research Affiliates recently published a great webcast about the CAPE, its current levels, and many of the criticisms put forward by its detractors. I found it to be pretty interesting, especially the discussion of the criticisms. So this if the first resource I am highlighting. You can check it out here.
I am definitely persuaded by the side of Professor Shiller in this debate. I mean, just check out the publication dates of the various versions of his Irrational Exuberance. That gives him 100x the credibility of most academics in my mind. Yeah, maybe he’s usually a couple of years early, but his track record smokes that of pretty much all of the Wall Street “strategists.” It is also not like his conclusions in his books was “buy gold doubloons” or bitcoin or go to cash or some other insanity. He just said, maybe you should rebalance some to bonds (in like 1997). Now he’s saying, maybe you should diversify abroad if you are a U.S. based investor (or save more). [I am also hoping to curry favor with him and perhaps obtain some of his secrets on how to look that young when I am 70+!]
Some other resources discussing the CAPE and its strengths and weaknesses can be found at Meb Faber’s site and there’s a really great relevant post on Philosophical Economics. The post on Philosophical Economics is the last in a series which you can read through by following the links in each article. My recollection is that his conclusion was basically, “Yeah, you could tweak the CAPE, but after modeling a lot of these proposed tweaks, they really have no material impact.”
Once you determine that you should care about the CAPE, another site with some really fantastic research/tools is maintained by a German firm, Star Capital AG. Ich spreche ein bisschen Deutsch…thankfully, you can select English and everything works very well. Select your country and your appropriate role and then click “Research.”
A menu pops up containing a number of interesting items, but we are interested in the ones under “Asset Allocation (Interactive).” Here is a link to the “Stock Market Valuation” screen under this tool. This page has a number of neat features, but basically it offers more detail and granularity than the other CAPE tools we have previously discussed. So you can look at the data on a country by country basis as opposed to looking only at U.S. versus EAFE versus Emerging.
It also offers a “heat map” of the world to quickly scan the globe for what is cheap or expensive. You can also look at other valuation metrics, such as price-to-book. One other pretty neat additional feature using all this data is that you can look at global sector valuations based on a number of ratios (not CAPE, but trailing 12 month P/E, P/B, P/S, etc). They also have some momentum indicator information in this data (and their models). I note that Life Insurance ranks #3 in their model and screens as one of the cheapest sectors globally on most metrics.
This is a resource post, so there are not really supposed to be any “actionable items.” As I noted above, Life Insurance looks to be one of the more depressed/cheap industries. It also seems “less crappy” and capital intensive than many of the other industries in a similar cheapness zip code (e.g., mining).
I will record for readers and my future self that, based on the relative expensiveness of U.S. markets as evidenced by the CAPE ratio (and other metrics), I am at maximum levels for my ex-U.S. allocation under my investment policy statement. This is mostly in retirement accounts, where I allow up to 50% of my equity exposure to be non-U.S.
I do have some misgivings about deploying capital subject to the political and legal systems underlying many foreign markets, especially those without a long (or any) history of the rule of law, respect for property rights, and democracy. You cannot build anything sustainable without a strong foundation. It seems likely, however, that valuation levels reflect some of this concern. To minimize these sorts of risks, I am generally using funds that overweight developed markets.