Saturday, 28 July 2012

The ASX 200 Cyclically Adjusted PE (aka ASX 200 PE10 or ASX200 CAPE) – July 2012 Update

This is the Retirement Investing Today monthly update for the Australian ASX 200 Cyclically Adjusted PE (ASX 200 CAPE).  Last month’s update can be found here.

Let us firstly look at the key ASX 200 market metrics:
-    The ASX 200 Price at market close on Friday is 4,210 which is 2.8% above last month’s Price of 4,095 and 4.9% down year on year.
-    The ASX 200 Dividend Yield is currently 5.0%.
-    The ASX 200 Earnings are currently 333.
-    The ASX 200 P/E Ratio is currently 12.6 compared with the a dataset (since December 1982) average P/E of 18.3

The first chart today shows a historic view of the Real (inflation adjusted) ASX 200 Price and the ASX 200 P/E.  The second chart provides a historic view of the Real (after inflation) Earnings and the Real (after inflation) Dividends for the ASX 200.

The first chart also shows a historic view of the metric that this post is interested in, which is the ASX 200 PE10 (effectively  an ASX 200 cyclically adjusted PE or ASX 200 CAPE for short).  The method is based on that made famous by Professor Robert Shiller and in this instance it is simply the ratio of Inflation Adjusted Monthly ASX 200 Monthly Prices to 10 Year Inflation Adjusted Average Earnings. 

Some of the ASX 200 PE10 metrics that may be of interest are:
    - ASX 200 PE10 is currently 14.2 which is 2.2% above last month’s 13.9.
    - The Dataset Average ASX 200 PE10 is 22.0.  If this average was “fair value” then it indicates that today the ASX200 is 35% undervalued.  I’m not convinced of this though and think it is a result of a relatively short dataset but as usual I’ll cover that later in this post.
    - The Dataset Median ASX 200 PE10 is 22.1.
    - The Dataset 20th Percentile ASX 200 PE10 is 16.8.
    - Dataset 80th Percentile ASX 200 PE10 is 27.5.

My third chart shows why I use the ASX200 PE10 ratio as part of the tactical portion of my Retirement Investing Today strategy.  This chart shows the ASX200 Price vs the Nominal 5 Year Total Return.   The correlation is -0.48 with an R^2 of 0.23.  With the ASX200 PE10 at 14.2 the chart trendline implies a future Nominal 5 Year Total Return of 86%.  Even if I adjust this metric for inflation (not charted today) the trendline implies a real return of 68%.

Finally, one problem this data has is that it is quite a short set.  For my own investments I therefore now try and correct for this by making quite a large assumption, which is that there is a high correlation between Australian Equities and International Equities performance.  With this assumption I then look at my mature S&P 500 dataset which tells me that since 1881 the average PE10 has been 16.4 and from 1993 it has averaged 26.6.  Taking a ratio of these two PE10’s and multiplying by the current ASX200 Average PE10 I arrive at a “pseudo long run” Average PE10 of 13.7.  Comparing that with today’s PE10 of 14.2 suggests the market is pretty much fairly valued and it is that data that I am making my own personal investment decisions on.   

As always DYOR.

Assumptions include:
- All historic figures are taken from official data from the Reserve Bank of Australia.
- Latest ASX200 P/E ratio is calculated using the 27 July 2012 Price and the June 2012 Earnings which is extrapolated from the RBA’s published P/E.
- July 2012 Price is the 27 July 2012 market close.
- July 2012 Earnings and Dividends are assumed to be the same as the June numbers.
- Inflation data for July 2012 is extrapolated.

1 comment:

  1. Hi,
    I don't fully understand the calculations, however the results are compelling. I really like the correlation data relating to the ASX200 CAPE. It provides a convincing statistical basis that can be used to predict market returns. I think you are doing a great service providing this information. I am surprised I have not seen this elsewhere. It has inspired me to invest in a low cost ASX200 Index ETF. Specifically STW.