PT  - JOURNAL ARTICLE
AU  - Robert D. Arnott
AU  - Denis B. Chaves
AU  - Tzee-man Chow
TI  - King of the Mountain: <em>The Shiller P/E and Macroeconomic Conditions</em>
AID  - 10.3905/jpm.2017.44.1.055
DP  - 2017 Oct 31
TA  - The Journal of Portfolio Management
PG  - 55--68
VI  - 44
IP  - 1
4099  - https://pm-research.com/content/44/1/55.short
4100  - https://pm-research.com/content/44/1/55.full
AB  - Because of mean reversion, the Shiller cyclically adjusted price/earnings (P/E) ratio is a powerful predictor of long-horizon capital market returns. Like other valuation metrics, however, it is a poor predictor of short-term returns. The authors find that this is because the “normal” level of the Shiller P/E ratio varies with economic conditions. Other researchers have shown that while periods of moderate real interest rates allow higher market valuations, P/Es tend to fall when real rates are high or low. The present authors show a similar linkage between P/Es and inflation. Moderate, rather than rock-bottom, levels of inflation and real interest rates are associated with the highest valuation multiples, creating a valuation “mountain.” The authors also extend these findings to international developed markets. They further demonstrate that the P/E ratio becomes a statistically significant and economically meaningful predictor of shorter-term returns under the assumption that P/Es mean-revert toward the levels suggested by prevailing macroeconomic conditions rather than toward long-term averages.TOPICS: Accounting and ratio analysis, developed