CFMV Q2-10 Final

8/8/2019 CFMV Q2-10 Final

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Q2-10

Combined Fair Market Value

(CFMV)

S&P 500 Fair Value

A Comparison of Professor Robert Shiller’s Cyclically Adjusted Price to Earnings (CAPE 10),Nominal Price to Earnings,Monthly Price to Earnings,

And Year – Over – Year Earnings Growth

By Chris Turner



I. Results for CFMV Q2-10:

The results for 2 nd Quarter CY-10 earnings (Apr-Jun) Turner Fair Market Value (TFMV) using data setsfrom the S&P Website (S&P Website ) and Professor Robert Shiller (Shiller Online Data ) are listed below:

A. Nominal period trailing earnings – Calculated using Shiller’s method of current S&P 500 Index priceat month close divided by average earnings over column period earnings.

B. CPI Adjusted (Shiller Method-CAPE) – Professor Shiller adjusts current S&P 500 Index price and 4quarter trailing earnings at month close by CPI, then divides CPI-adjusted price by CPI-adjustedearnings 10 years. The 10 year calculation is the original Shiller Method – the other periods arecalculated the same method but for differing periods.

C. Monthly P/E Averages – Calculated by dividing monthly price by monthly 4 quarter trailing earnings.NOTE: This calculation results in the same number whether using CPI or nominal.

D. Historical Y-O-Y Earnings Growth: Calculated by averaging of entire time period earnings growthyear over year.

E. Combined Fair Market Value - Calculated by averaging Current Price (sentiment), average of allperiods nominal and Monthly P/E, and Y-O- Y earnings growth. This does not include Shiller’s CAPE.S&P Index = Average of daily closes for month end June 10.

http://www.standardandpoors.com/



http://www.econ.yale.edu/~shiller/data.htm







II. Background:

A. PROFESSOR SHILLER : Yale Professor of Economics Robert Shiller, (Bio Here ), developed acyclically adjusted price to earnings ratio (CAPE) that simply uses monthly CPI- adjusted S&P 500Index and divides that by an average of 10 years worth of CPI adjusted trailing monthly earnings.Professor Shiller uses this data and creates a long term chart that compares this ratio over time with abackdrop of long term interest rates – shown below:

NOTE: Shiller Chart as of 13 Oct 2010 (21.17 does not reflect latest earnings for Q2 – using Q2 earnings, Shiller’sdata would be 19.70)

B. CAPE METHOD – Professor Shiller uses the long term average for price to earnings for 10 years(currently 16.36) to arrive at an over or under valued metric based on those earnings. The value 19.70minus 16.36 provides an overvalued metric of 16.94%. With the S&P June Index at 1083 (average of daily closes for June 10), a 17% percent correction would result in the S&P being 898 as fair value.

C. PURPOSE – Financial pundits, economists, and TV persona seem to relish Shiller ’s chart and do notquestion the metrics involved in creating the chart. The first question that occurred to me was “Whyuse the BLS CPI?” Head over to John Williams Shadowstats website and we see that BLS ch angedmetrics back in the early 80’s and inflation has been underreported by as much as 7% at present.Wouldn’t this change the picture? To answer that question – I downloaded Shiller ’s data – and beganto examine the spreadsheet. By analyzing the data, I wanted to determine what impact, if any, a changein the CPI vs nominal might exist.

http://www.econ.yale.edu/~shiller/bio.htm






D. FAIR VALUE – Each investor uses some metric to determine a “fair value.” As indexes work inaggregate, assigning a “fair value” to the overall S&P 500 index is cumbersome. However, sinceShiller went through the process of assigning his fair value to the CAPE for 10 years – I went manysteps further and compared differing time periods for both nominal (no CPI adjustment) and CAPE

(CPI adjusted), then compared the averages for all time periods.

III. Methodology :

A. Shiller CAPE Calculation – After a quick perusal of Shiller’s data, some interesting points about thedata surfaced. First, Shiller’s calculation is not just using the si mple 10 year average of monthlyearnings, it is actually 10 years of 1 year of trailing earnings. To clarify:

The data on the left from Shiller’s spreadsheet shows the total earnings (this is GAAP or actual

earnings BTW, not operating) under the Earnings column. A quick glance over at the S&P website(right picture line 54) confirms that looking at quarterly earnings of 6/30/2008 reveals earnings of $12.86. However, on Shiller’s line 1658, the number is 51.37. So – I added a column to S&P(shown far right) to calculate 1 year trailing earnings and voila – the earnings agree.

Shiller then uses this 1 year of trailing earnings (commonly referred to as trailing twelve monthsearnings - TTE) and divides price (defined by average of monthly closes) by 10 years average of the

trailing earnings. This creates the underlying data set for his chart. So far, all the data makes sense. Iwent one step further with Shiller’s data a nd assigned an over/under value based on the index vs justshowing the raw P/E ratio. Then, rather than looking at a chart with a comparison of long terminterest rates, I changed the background to either the historical nominal or CPI adjusted S&PIndex . By doing this, a comparison to the actual index can be made rather than an interpretationof where the index should be – I actually calculated Shiller’s data to make the informationrelevant. (Considerable improvement)…



Since Shiller desires to smooth data – which is understandable – the second question that came to mindwas “Why 10 years?” Isn’t this the same time that the following occurred:

1) Credit expanded feverishly2) Record Mortgage Equity Withdrawal3) Record Securitization4) Negative savings rate

5) Peak baby boomer earnings (40-50)To compare 5, 10, 20, and 30 years goes further to answer the relevancy of the data based on differingtime periods and smoothing the impact of the previous 10 years.

B. Nominal Period Trailing Earnings Calculation – These calculations are the exact same as Shiller’sCPI adjusted, except these are unadjusted numbers. Last time I checked, no one really trades a cpi-adjusted Index anyway … Additionally, the differences between the nominal and CPI adjustment aretoo small. The chart below shows the actual difference between Shiller’s CAPE data and simply usingthe nominal number. Clearly, the differences are subtle and perhaps adjusting for CPI isunnecessary.

C. Monthly P/E Averages – While researching the data, another metric came to mind. What about thehistorical monthly price divided by earnings? What would those charts look like for 1 year (essentiallythe monthly price divided by the earnings which is the 4 quarter trailing earnings), 5 year, etc…



D. Historical Y-O-Y Earnings Growth – I also calculated the 1871 to present day average of 1 yearearnings growth to arrive at the long term average. This number shows more of a linear representationof where the S&P would be based upon the long term average of earnings growth.

E. Combined Fair Market Value – A number predicated on all calculations using an average of sentiment (current price), nominal (because we trade nominally), Y-O-Y earnings growth, and monthlyP/E values.

F. Geometric VS Arithmetic Calculations – I contacted Andrew Smithers in the UK about usinggeometric vs arithmetic calculations. He uses Geometric for his chart (Click Here ) that comparesTobin’s Q ratio (Q Ratio Explained ) and Shiller’s CAPE. Geometric is appropriate for Earnings Per share calculations over time, however Price divided by earnings are “snapshots” in time and arithmeticaverages work. In fact, the differences in calculations from Geometric and arithmetic are in thedecimals (I calculated both ways) and again – when talking generically of over and undervalued,whether the S&P fair value is 899.01 or 899.05 becomes irrelevant.

G. Logarithmic vs Actual – Most charts are using Logarithmic due to the long time horizon. Once thetime horizon passes 30 years, using actual index numbers (even CPI adjusted) prevents a truerepresentation. Comparing Shiller’s original chart and the logarithmic chart shows t he 1929 vs 2000bubbles in much better context.

IV. Charts:

A. CFMV – 1871 to Present

http://www.smithers.co.uk/page.php?id=34



http://en.wikipedia.org/wiki/Tobin%27s_q







B. Original Shiller CAPE – 1871 to Present (original Shiller data applied to logarithmic scale)

C. Charts included in Attachment:

1. CAPE 5 year2. Nominal 5 year3. CAPE 10 year (Shiller Original data)4. Nominal 10 year5. CAPE 20 year6. Nominal 20 year7. CAPE 30 year8. Nominal 30 year9. 5 year Monthly Price divided by Earnings Average10. 10 Year Monthly Price divided by Earnings Average11. 20 Year Monthly Price divided by Earnings Average12. 30 Year Monthly Price divided by Earnings Average13. TFMV 1871 to present14. TFMV 1950 to present

V. About the creator:

Chris Turner, resides in Kansas, full-time pilot for military with a part-time hobby for economic andmarket research. Independent options trader and managing partner for small Investment LLC.



ATTACHMENT 1

1. CAPE 5 year 2. Nominal 5 year 3. CAPE 10 year (Shiller Original data) 4. Nominal 10 year 5. CAPE 20 year 6. Nominal 20 year 7. CAPE 30 year 8. Nominal 30 year 9. 5 year Monthly Price divided by Earnings Average 10. 10 Year Monthly Price divided by Earnings Average 11. 20 Year Monthly Price divided by Earnings Average 12. 30 Year Monthly Price divided by Earnings Average 13. CFMV 1871 to present

14. CFMV 1950 to present



CAPE 5 year

Nominal 5 year



CAPE 10 year (Shiller Original data)

Nominal 10 year



CAPE 20 year

Nominal 20 year



CAPE 30 year

Nominal 30 year



5 year Monthly Price divided by Earnings Average

10 Year Monthly Price divided by Earnings Average



CFMV 1871 to present

CFMV 1950 to present

CFMV Q2-10 Final

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