Apple’s freakish growth broke this market barometer
The once-reliable CAPE (cyclically adjusted price-earnings) ratio, a long-standing gauge of stock market valuation, has recently fallen short as a predictive tool. The extraordinary earnings growth of tech giants like Apple and other big tech companies has distorted this traditional market barometer. As investor concerns about overvaluation intensify, there’s a growing need to refine the CAPE ratio to better reflect current market conditions.
The CAPE attempts to answer a basic question: When investors buy a stock, they are essentially buying a stake in a company’s earnings, so how much are they paying for those earnings? The CAPE normally applies that question to a broad tracker, such as the S&P 500 Index, by calculating the ratio of the index’s price to a 10-year trailing average of its earnings per share after inflation.
So, for example, the S&P 500 closed at 5,319 last Thursday, and its 10-year trailing average earnings are $168 a share after inflation, according to Bloomberg data, which amounts to a CAPE of 32 times. That’s high — nearly double the long-term average since 1881 and the third highest ever, exceeded only at the height of the internet bubble in the late 1990s and earlier this decade.
To CAPE connoisseurs, it’s a worrisome signal of disappointing stock returns ahead because historically, a high CAPE is strongly correlated with lower future returns, and vice versa. But the CAPE has averaged a stubbornly high 28 times since 2010 — near its current level and well above its long-term average of 17 — and yet, the S&P 500 has ground higher. The index returned 13.8% a year through July, including dividends, one of the best 15-year periods on record. Investors who lightened up on stocks in fear of a high CAPE made a costly mistake.
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MacDailyNews Take: If you’re a “CAPE connoisseur” and not talking about Cape Cod in the summer, seek help immediately.
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