GMO examines whether critics of Shiller’s CAPE ratio are overlooking how elevated profit margins and distorted earnings may still imply expensive U.S. equities. James Montier argues alternative valuation methods, including Tobin’s Q and peak earnings models, largely reinforce the same uncomfortable conclusion despite bullish objections.
A CAPE Crusader ─ A Defence Against the Dark Arts
GMO
James Montier
Research
8 Pages
Key Takeaways
Trend Earnings Inflation: Replacing trailing 10 year earnings with trend earnings lifts CAPE from 25x to 34x, suggesting valuations may appear cheaper than underlying fundamentals justify.
Profit Margin Dependence: NIPA profits averaged 8% of GNP over the prior decade versus a 6% long term average, implying unusually strong margins may be inflating valuation assumptions.
Muted Return Outlook: Five valuation models produced average seven year real return expectations near 0%, while GMO’s blended framework projected a negative 1.1% annualized real return for the S&P 500.
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