This was inspired by Greenblatt's comment about one-year forward expected returns in the market based on P/E level. While bears are always telling us how overvalued the stock market is, Greeenblatt seems to always come up with a positive one-year forward expected return. He uses data from the past 30 years to calcluate this, but I was worried that this time period might be a little biased due to the large and persistent decline in interest rates for this period. So I decided to look at this myself over a longer time period.

Note: 1991.12 is December of 1991, the P/E is the P/E or CAPE10 at that time, and the return is the total return over the following 12 months.

Data source: Shiller

Since 1985:

P/E level of over: 20

Number of up years: 11

Total # years: 15

Percent up years: 73.33%

Average change: 5.5%

Date | P/E | return |
---|---|---|

1991.12 | 24.33 | 15.32% |

1992.12 | 22.82 | 9.85% |

1993.12 | 21.29 | 0.52% |

1997.12 | 24.23 | 25.34% |

1998.12 | 31.56 | 21.45% |

1999.12 | 29.66 | -5.70% |

2000.12 | 26.62 | -12.79% |

2001.12 | 46.37 | -20.06% |

2002.12 | 32.59 | 22.11% |

2003.12 | 22.17 | 12.77% |

2004.12 | 20.48 | 7.09% |

2007.12 | 22.35 | -38.75% |

2008.12 | 58.98 | 29.08% |

2009.12 | 21.78 | 13.86% |

2014.12 | 20.08 | 2.10% |

2015.12 | 23.74 |

The data excludes total return for 2016, but we know it was more than 11%, so the results would be even stronger.

Since 1871:

P/E level of over: 20

Number of up years: 14

Total # years: 20

Percent up years: 70.0%

Average change: 5.9%

Date | P/E | return |
---|---|---|

1894.12 | 26.88 | 4.88% |

1896.12 | 20.10 | 16.82% |

1921.12 | 25.21 | 27.09% |

1933.12 | 22.66 | -2.61% |

1961.12 | 22.49 | -9.72% |

1991.12 | 24.33 | 15.32% |

1992.12 | 22.82 | 9.85% |

1993.12 | 21.29 | 0.52% |

1997.12 | 24.23 | 25.34% |

1998.12 | 31.56 | 21.45% |

1999.12 | 29.66 | -5.70% |

2000.12 | 26.62 | -12.79% |

2001.12 | 46.37 | -20.06% |

2002.12 | 32.59 | 22.11% |

2003.12 | 22.17 | 12.77% |

2004.12 | 20.48 | 7.09% |

2007.12 | 22.35 | -38.75% |

2008.12 | 58.98 | 29.08% |

2009.12 | 21.78 | 13.86% |

2014.12 | 20.08 | 2.10% |

2015.12 | 23.74 |

What happens if we do the above with a 25x P/E threshold?

Since 1871:

P/E level of over: 25

Number of up years: 5

Total # years: 8

Percent up years: 62.5%

Average change: 8.3%

Since 1985:

P/E level of over: 25

Number of up years: 3

Total # years: 6

Percent up years: 50.0%

Average change: 5.7%

Just to be thorough, I reran all of the above using all months, not just year-end. I looked at all months where the P/E ratio was over 20x or 25x and what the total return was 12 months later.

Since 1871:

P/E level of over: 20

Number of up years: 139

Total # years: 223

Percent up years: 62.3%

Average change: 3.5%

Since 1985:

P/E level of over: 20

Number of up years: 111

Total # years: 162

Percent up years: 68.5%

Average change: 4.8%

Since 1871:

P/E level of over: 25

Number of up years: 58

Total # years: 96

Percent up years: 60.4%

Average change: 5.1%

Since 1985:

P/E level of over: 25

Number of up years: 54

Total # years: 90

Percent up years: 60.0%

Average change: 5.2%

Someone pointed out that CAPE10 might be more interesting to look at for this analysis as some years like 2008 show high P/E's due to depressed earnings (even though depressed earnings will push up CAPE10 too). Here are the results:

Since 1871

P/E level of over: 20

Number of up years: 23

Total # years: 33

Percent up years: 69.7%

Average change: 5.2%

Since 1985

P/E level of over: 20

Number of up years: 17

Total # years: 21

Percent up years: 80.95%

Average change: 8.5%

Since 1871

P/E level of over: 25

Number of up years: 9

Total # years: 14

Percent up years: 64.3%

Average change: 4.5%

Since 1985

P/E level of over: 25

Number of up years: 9

Total # years: 13

Percent up years: 69.2%

Average change: 5.2%

Since 1871

P/E level of over: 20

Number of up years: 281

Total # years: 410

Percent up years: 68.5%

Average change: 5.9%

Since 1985

P/E level of over: 20

Number of up years: 194

Total # years: 251

Percent up years: 77.2%

Average change: 9.4%

Since 1871

P/E level of over: 25

Number of up years: 93

Total # years: 153

Percent up years: 60.8%

Average change: 4.2%

Since 1985

P/E level of over: 25

Number of up years: 91

Total # years: 139

Percent up years: 65.5%

Average change: 5.96%