After the Correction… Are Stocks Cheap?

We finally got that 10% correction we’ve all been waiting for. Last week’s volatility finally put us into official correction territory for the first time since 2011. It also gave us one of the biggest intraday swoons in market history as the Dow dropped by over 1,000 points last Monday. So after the August carnage, is the stock market finally cheap again? Not even close. Let’s take a look at the cyclically-adjusted price earnings ratio (“CAPE”), a popular back-of-the-envelope metric used by many value investors – myself included – to gauge the overall cheapness of the market. And as you can see from the chart below, last week’s carnage barely made a dent.

The CAPE, at 25.2, is still sitting at elevated levels. That’s more than 50% higher than the long-term average. Data site GuruFocus crunched the numbers, and a CAPE reading at these levels implies that returns over next eight years will be a pitiful 0.5% per year. Now I should be clear here: CAPE is not a forecasting tool with surgical precision. Mixing metaphors a little here, I’d consider it more of a hand grenade than a sniper rifle. This model is designed to give a rough estimate, and I do not for a second believe that annual stock returns will be exactly 0.5% per year. But I’m pretty comfortable saying that, at the very least, we should expect returns to be a little on the disappointing side starting at today’s prices.

Source: Charles Sizemore

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