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A CAPE Crusader
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A CAPE Crusader

A Defence Against the Dark Arts

James Montier
GMO, 2014
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Editorial Rating

7

Qualities

  • Innovative
  • Visionary

Recommendation

Investing has never seemed so confusing. A scant few years ago, investors could just balance the ratio of bonds and stocks in their portfolios to their desired risk level, include some geographic and industry diversity, and maybe spice up the mix with some well-chosen commodities and derivatives. Now, markets rise with bad news and fall with good news, except when they don’t. While getAbstract never offers investment advice, it recommends this paper’s methodical approach to assessing new thinking on valuations and expected returns. Any new valuation scheme faces two queries: Is the old one really broken and is the new one really better?

Take-Aways

  • Some market watchers criticize Shiller’s Cyclically Adjusted P/E (CAPE) ratio as being too pessimistic because it consistently paints the stock market as being overvalued.
  • They suggest an alternate ratio based on the US government’s National Income and Products Account (NIPA), which tracks profits from some 9,000 firms in a wide range of sizes and sectors.
  • The NIPA CAPE offers a P/E ratio that is lower than Shiller’s but still above average.

About the Author

James Montier, former co-head of Global Strategy at Société Générale, is with the investment management firm GMO. His books include The Little Book of Behavioral Investing.

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