While I have great respect for Shiller, I don’t understand his confidence that the CAPE is likely to return to it’s historical average of around 16. There are several reasons why we might expect the average CAPE going forward to be higher than in the past:
1. The average levels of CAPE in most of the last century appear, with hindsight, to have been puzzlingly low. This is the well-known “equity premium puzzle.”
2. There has been a large shift in corporate payout mix, from virtually all dividends in the past, to a roughly equal mix of dividends and share repurchases today. This by itself will add a couple of points to CAPE even if nothing else changes, (as shown in this post by the anonymous blogger who tweets as “Jesse Livermore”): http://www.philosophicaleconomics.com/2013/12/Shiller/
3. Some other accounting changes to the definition of profits might raise the CAPE as well, again see the linked blog post above.
4. Lower information and transaction costs and the rise of index investing have dramatically lowered the cost of maintaining a globally diversified portfolio. This decreases the raw rate of return for any given required rate of realized returns. For example if the costs of investing in equities fall by just 50 basis points, this would allow the required raw earnings yield to fall from 5% to 4.5%, corresponding to a rise in CAPE from 20 to 22, without changing realized returns for investors.
5. The real “risk free” return on treasuries seems to be very low by historic standards. Real returns on other forms of debt also appear low. This lowers the return stocks need to be attractive by comparison.
6. Large corporate cash balances, a “global savings glut,” lower rates of real economic growth, possible “secular stagnation,” all seem to point to the idea that real returns are somewhat harder to get than the past.
Some of these reasons are more certain than others, but taken together they seem to show that we have good reason to expect CAPE levels significantly above the historical average going forward.
Are there any countervailing reasons offsetting the list above, factors that would tend to make CAPE lower than in the past? I can’t really think of any. And I haven’t seen anybody else offering any.