Shiller PE Ratios: Can they Predict Future Returns?

A Yale Professor, Dr. Robert Shiller, has for decades developed a model for predicting future stock market returns called the Shiller PE Model. His premise is very simple. Higher PE ratios above 17 will result in poor subsequent 10 year performance, compared to lower PE ratios below 17 will result in superior subsequent 10 year performance.

See chart below for results since 1929:

Shiller P/E's and Average Stock Returns

Date Range PE Annual Return

1929-1938 26.7 3.55%

1939-1948 16.2 7.70%

1949-1958 9.9 21.56%

1959-1968 18.0 10.63%

1969-1978 20.8 4.84%

1979-1988 9.2 16.65%

1989-1998 15.1 19.86%

1999-2008 40.4 0.65%

Average 17.4 11.09%

Currently, the Shiller PE stands ironically at 17. Dr. Shiller suggests that most investors do not have the patience or the fortitude to craft a long-term allocation that will benefit from the market's over and under valuations. At this point in time, Dr. Shiller suggests investors should be equally weighted between stocks and bonds.

On the other hand, the uncertainty of future corporate earnings, and the overzealous nature of investors could force the Shiller PE ratio to rise or fall substantially in the near term. Moreover, the "E" (earnings) is currently very unpredictable, in that, future earnings expectations for corporations could go in either direction.

By David A. Mascio