Emerging Markets Cheap Based on CAPE; So Does CAPE Work in EM?VW Staff
As we showed earlier based on CAPE, emerging markets are both cheap in relative terms to places like the US and other markets, and are cheap on an absolute basis. The next question is does CAPE work (assuming it works in the US) outside of the US? To that we look to a recent white paper published by Joachim Klement of Wellershoff & Partners Ltd. in 2012.
The topic of his research is as follows:
We test the reliability of the Cyclically Adjusted PE (CAPE) or Shiller PE as a forecasting and valuation tool for 35 countries including emerging markets. We find that the Shiller-PE is a reliable long-term valuation indicator for developed and emerging markets and we use the indicator to predict real returns on local equity markets over the next five to ten years.
Furthermore regarding non US CAPE and emerging markets included the author notes:
While for some developed markets like the UK the necessary long-term historical data on prices, earnings and inflation is reasonably easy to get in order to check the validity of this approach outside the United States, it is less clear, whether this approach can also inform our understanding of equity market valuations in smaller developed countries or emerging markets where growth and inflation dynamics may differ significantly from the United States or the UK.
In this report we use long-term historical data on equity market returns, earnings, inflation and growth to assess the validity of the Shiller-PE as a predictor of future long-term equity market returns. We use the same methodology as Campbell and Shiller and calculate the Shiller-PE as the ratio of current real price of a stock market (adjusted by inflation) by the average real earnings over the last ten years.