Tuesday, 21 June 2011

The FTSE 100 cyclically adjusted PE ratio (FTSE 100 CAPE or PE10) – June 2011

While we all sit back and watch the train wreck that is Greece prepare to default (or whatever posh name they will come up with in due course) the UK goes on happily borrowing money at the rate of £17.4 billion for the month.  That’s £17,400,000,000 in a month.  What’s concerning me is that servicing our debt now takes 8.5% of government spending.  That’s more than the complete tax take from corporation tax (page 6 here).  All I can say is that the future generations will not be pleased.  I’m just a simple Average Joe but it really just doesn’t seem right asking children who are not yet born to pay for our lifestyle today.    
As this all unfolds we’ve seen stock markets around the world decrease in price in recent times.  I actually have no idea what moves prices (that’s why I don’t trade) but I can’t help feel that Greece is having a good impact but also we shouldn’t forget good news like this from China.

What I do know is that my Retirement Investing Today strategy has helped me out over this period.  This is because in addition to a standard buy diversified asset types, hold, rebalance periodically, reduce risk as I age strategic asset allocation I also tactically alter my asset allocation based on the cyclically adjusted PE values (CAPE or PE10) of the S&P500 and the ASX200.  To put some meaning behind this were I using just strategic asset allocations the total target equity (UK, Australia, International, Emerging Markets) allocation for my portfolio would be 61%.  Currently because of the relatively high PE10’s the tactical portion of my portfolio forces this down to 54%.  So with a falling market I am losing less than I would have otherwise.  Of course I mustn’t forget the opposite occurs in a rising market.

With all that in mind it’s appropriate to update the FTSE 100 cyclically adjusted PE (FTSE 100 CAPE) which I show in my first chart today.  As of the 01 June 2011 (all previous data points are from the first trading day of each month for consistency) we were sitting at 13.6 against a long run average (well since 1993) of 19.7.  If I replace the 01 June price with the current price as I write this post of 5747.8 the PE10 lowers to 13.2.  That is a long way below the 20th Percentile for the dataset of 16.3 while the 80th Percentile is 23.5.  The correlation between the FTSE 100 PE10 and the Real (inflation adjusted by the CPI) FTSE 100 Price remains a strong 0.68.  In comparison the PE ratio is sitting at 11.3.

My second chart shows that real earnings are doing nothing special and are running about on trend.
Finally as always I must point out that I am not yet using the FTSE 100 PE10 as a base for determining UK equity asset allocations and buy/sell decisions in my portfolio.  This is because I believe that a dataset only going back to 1993 is not sufficient however over time as this dataset becomes more statistically significant I will at some stage switch to it.  Today I am using the S&P 500 PE10 where I have data back to 1881 courtesy of Robert Shiller.  Not perfect but I’m relying on the close correlation of Equity markets around the world.  

As always do your own research.

Assumptions include:
-          May 2011 price is the 01 May 2011 market close.
-          UK CPI inflation data from May and June 2011 are estimated.


  1. "All I can say is that the future generations will not be pleased. I’m just a simple Average Joe but it really just doesn’t seem right asking children who are not yet born to pay for our lifestyle today."

    Economics is not (always) a morality play. What may be right for an individual, a family, or a business ("live within its means") may paradoxically, in some circumstances ("liquidity trap"), be a disastrous mistake for a government to make. Some food for thought:


  2. Hi Anonymous

    Population of the UK - 61,838,154 (2009 figure). Borrowings last month - £17,400,000,000. So the government borrowed £281 for every man, woman and child in the UK in last month alone. That is not right, ever.

    Of course governments are working on the proviso that it will never be paid back however I think the current world going ons are proving that to not be the case. Obviously my favourite, inflation will do some of the work for them, as they debase the currency. Inflation won't hide it all though and eventually if you keep borrowing you get to Greece levels of debt and then it realy doesn't work out so well for the masses.

    No thanks. I'll take the liquidity trap (balanced books)now for a more sustainable future tomorrow.


  3. Interesting that even allowing for the dotcom bubble the PE is so much less now that two decades ago. Nothwithstanding a possible crash in the next few months, this seems positive for equities in longer term.

  4. Hi SG

    I'm currently finding the FTSE100 PE and PE10 intriguing. The bit that I'm wondering about the most is the E part of the equation. Look at how real earnings went linearly through the roof from about 2004. A lot of that was world debt fueled I'm sure. Earnings today are back to 526 which is a long way above the 350 or so from 1996 to 2004.

    The question is which is the sustainable one. If earnings were to revert to 350 tomorrow the PE would be about 17.

    Cheers RIT

  5. Yes, I think that is a good point. Given the medium term outlook for growth, the recent recovery in earnings may be overdone.

  6. "So the government borrowed £281 for every man, woman and child in the UK in last month alone. That is not right, ever."

    If the government borrows from UK residents then that is inside the family and so cancels out, so the critical figure is the external debt which is much lower

  7. I think the FTSE PE10 is extremely misleading. The average S&P CAPE since 1881 is 16.4 whereas its 26.9 since 1993. Given the very correlation with the UK I would have thought adjusting the FTSE CAPE makes more sense i.e using 39% less = 12. so FTSE is overvalued (or may not be at 5,000 as I write)

  8. Come back! :) Now would be a great time for an update... ;)

    Hope all's well.

  9. whats happened to the blog? this is a crazy useful resource - hope its not bit the dust...