As shown in my first chart the ASX200 cyclically adjusted PE (ASX200 PE10 or CAPE) has been steadily declining since February. Today with the ASX200 closing at a price of 4567 the PE10 is 15.8 compared to the long run average since 1993 of 22.4. A quick look at these two values would suggest that the ASX200 is undervalued however I’m not so sure. The problem for me is that the data set that I have is a short period of time. Comparing the ASX200 to the S&P500 where I have S&P500 PE10 data going back to 1881 allows for a very crude extrapolation though. The long run average S&P500 PE10 is 16.4 however the average PE10 for the same period as my ASX200 dataset is 26.9. Extrapolating this to a long run average ASX200 PE10 reveals (22.4/26.9)x16.4=13.7 which would imply that the ASX200 is in fact not undervalued but overvalued to the tune of about 15%. To put this value in to perspective the PE10 low during the Global Financial Crisis (GFC) was 13.8 in February of 2009.
I’m struggling somewhat to comprehend that during the market low of the GFC we only saw the ASX200 reach fair value. I don’t know quite what to make of it... Of course my extrapolation is very crude but it does give food for thought.
The change in the ASX200 PE10 forces me to update the Australian equities tactical asset allocation of my Retirement Investing Today portfolio. From a strategic allocation of 20.5% when the PE10 is 16 my target tactical allocation is now 20.6%.
My second chart today is new for Retirement Investing Today. In the past this chart has always looked at the ASX200 PE10 versus the 1 year real (inflation adjusted) return (price gain + dividends). Today I am shifting the analysis to be the ASX200 PE10 versus the 5 year non-inflation adjusted return where the correlation is -0.33. I have shifted my analysis to this dataset as I am trying to understand what returns may be possible between now and my retirement which I hope will only be around 5 years from today. I have also shifted to nominal return rather than real return as whether I like it or not inflation is here to stay. The calculation method assumes that dividends are taken off the table at the end of each year (so 5 sets of dividends per data point) and they are held in a 0% interest account. Of course I’m reinvesting my dividends but this method makes the maths easy. The results in the chart show that for an ASX200 PE10 of 15.8 a possible return of between 70-90% could be possible over the next 5 years. Of course the usual problem is the small dataset but also the fact that this chart does not include the big stock market falls that we saw during the GFC. This is because this dataset only tracks to June 2006 (5 years ago) giving us still a little over 12 months to the real market peak. It will be interesting to watch this chart as we enter the peak of 2007 and move in to the GFC.
Additional CAPE/PE10 data for this month includes:
- the correlation between the ASX200 Price and the ASX200 CAPE remains at 0.75.
- the ASX 200 PE10 20 Percentile for my dataset is 17.1
- the ASX 200 PE10 80 Percentile for my dataset is 27.6
Today’s 3rd chart today shows Real (after inflation) Earnings and Real Dividends for the ASX200. Dividends are at 202.9 which is still below the long term trendline. Earnings on the other hand are pretty much on trend at 288.8.
As always do your own research.
Assumptions include:- All historic figures are taken from official data from the Reserve Bank of Australia.
- Latest ASX200 P/E ratio is the May 2011 ratio taken from the RBA official data of 16.3
- June 2011 price is the 15 June 2011 market close.
- June 2011 Earnings and Dividends are assumed to be the same as the May numbers.
- Inflation data from April, May and June 2011 are extrapolated.