Using the CAPE ratio to trade stocks is foolish!
Great article about market timing using the CAPE valuation ratio. The CAPE ratio attempts to find markets either over – or undervalued – by using current stock prices and comparing their average last 10 years inflation adjusted earnings. The idea is it smooths out the bumps in the markets, and identifies business cycle trends.
When the market is overvalued, it’s time to lighten up on stocks. When it’s undervalued, it’s time to get more aggressive.
There’s one big problem with using this valuation method – it’s great to identify PAST exit and entry points, but doesn’t work out so well for CURRENT entry and exit points.
In the attached PDF, Weston looked back at one glaring CAPE valuation signal – 1996. The CAPE ratio was at 27 – or well above it’s long term average of about 17.
The signal was clearly a sell! Yet the markets went on to even higher valuations. The market averaged about 7% per year since 1997 (through June of 2014), while treasury bills earned a meager 2.4%.
Yet another chunk of proof that you can’t time the markets!
Here’s the article:
