Goldman Sachs destroys one of the most persistent myths about investing in stocks 🤯
The sacred CAPE ratio is problematic🤦♂️
Let’s talk about the CAPE ratio. It’s one of the most widely-followed stock market valuation metrics. It’s being talked about more as investors wonder whether stocks are poised to lose ground in 2022. Unfortunately, the signal of doom it supposedly sends is a myth.
CAPE, or cyclically adjusted price-earnings, was popularized by Nobel prize-winning economist Robert Shiller.1 It’s calculated by taking the price of the S&P 500 and dividing it by the average of 10 years’ worth of earnings. When CAPE is above its long-term average, the stock market is thought to be expensive.
Many market watchers use above-average CAPE readings as a signal that stocks should underperform or even fall as it reverts back to its long-term mean.
But CAPE’s mean doesn’t actually have much pull.
‘An oft-repeated myth’
“While valuations feature importantly in our toolbox to estimate forward equity returns, we should dispel an oft-repeated myth that equity valuations are mean-reverting,” Goldman Sachs analysts wrote.