I would like your opinion on an original issue I have with the Shiller PE10 index. I wrote a blog post on that subject (and I merely did it to get feedback):
I had seen too many Shiller PE10 indices, and investment decisions which depend on it (last one being the GMO Capital “13th Labour of Hercules” White Paper). Found here: 13thLabourofHercules
Seth Klarman: Investors Can No Longer Rely On Mean Reversion
"For most of the last century," Seth Klarman noted in his second-quarter letter to Baupost's investors, "a reasonable approach to assessing a company's future prospects was to expect mean reversion." He went on to explain that fluctuations in business performance were largely cyclical, and investors could profit from this buying low and selling high. Also Read More
In a nutshell: P/E10 is used where the denominator is inflated by official CPI-U, which has changed definition over time, with a wide convergence compared to the inflation indicated by a historic (1980, 1990) CPI-U index definition.
If you recalculate the Shiller PE10 with earnings inflated with “real inflation” (which I did in my post), you get 17 instead of 22 for today (roughly).
John Chew’s reply: I applaud your efforts to correct a distortion but any government aggregate is flawed. See article on the CPI below. Your adjustment may be less flawed but still you may not have a worthwhile tool/indicator. I mostly focus on individual companies and disregard discussions on market P/E. First the P is distorted by the FED and the Earnings are distorted by GAAP accounting. I would rather spend time on understanding the quotation (under the cartoon) on the stock market.
Hint: I highly recommend that you read this book: Stock Market, Credit, and Capital Formation
The above book is crucial to understanding the credit cycle’s influence on the stock market!
I don’t have a clue on how to advise you. However you go here and read Crestmont’s discussion on adjusted PEs.
Also, any aggregate number is distorted–see comments on the fantasy of using Gross Domestic Product as an indicator for economic growth.
Should we believe in GDP?: http://mises.org/daily/3843
What is wrong with the CPI http://mises.org/freemarket_detail.aspx?control=368