The Shiller PE ratio for the S&P 500 is based on average inflation-adjusted earnings from the previous 10 years. It is also know as the the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio or the P/E10.

  The CAPE utilizes earnings from the prior 10 years. The numerator is the real value of the S&P 500. Real meaning adjusted for inflation. The denominator is the moving average of the preceding 10 years of the S&P 500 real reported earnings.
  

 The purpose of the CAPE looking at the previous 10 years real reporting earnings is to control business-cycle effects.  The caution here would be that business cycles typically last 6 years. Recent trends indicate that recessions are shorter and expansions are longer. The risk would be that the CAPE tends to overestimate true average earnings during contractions and underestimate average earnings during recessions.  

 As we discussed last week, the Bureau of Labor Statistics often changes the manner in which the CPI is determined. This will have an impact on the reported inflation number. Changes also occur to the corporate taxation policies and accounting standards.  Non-recurring, one time charges, earnings impacted items are reflected for a full 10 year period. Other measures treat these 'one timers' in the current period and leave them behind when measuring current periods. Another factor to take into account is that the stock market can remain over valued for a long time before any type of correction takes place.

 What do you use to measure the market? Do you still believe that this rally is Fed driven only? Do you reference the CAPE, P/E only, forward and TTM P/Es? Five-year normalized P/E? Throw darts? Recommendation is to consult them all, do your homework, do your best. Sua Sponte.


Bradford C. Bruner for Sua Sponte Wealth Management.

    If you have been unemployed, underemployed, or employed with no raise during this recession, you may have been paying particularly close attention to the inflation numbers.

    Inflation is the rise in the level of prices of goods and services over a period of time. When the price level increases, our dollar buys fewer goods and services. Inflation reflects a reduction in the purchasing power of the dollar.

    The Consumer Price Index (CPI) is the standard measure of inflation. The CPI measures a basket of goods and services from 12,200 selected households. The change in cost is the inflation rate. The case can be made that this measure overstates the inflation rate because it does not take into account that consumers continually adjust buying patterns to purchase the most inexpensive items.
   

    Not new, but not often apparent to the consumer is the chain-weighted version of the CPI. The PCI, Personal Consumption Expenditure, continuously updates data to reflect changes in spending patterns.  The Bureau of Economic Analysis first starting using this data in 2002. Under this index, inflation runs at 1/3 point lower and under the chain-weighted CPI, 1/4 lower than the traditional CPI.

    The Federal Reserve Board uses the PCE for its economic forecast and decisions surrounding inflation. As long as the PCE and CPI are reacting the same, all should be good.  Up until recently they have been.  Currently, PCE shows inflation at 1.1% while the CPI has inflation running at 1.9%.
    
    With close to 1 percentage point between the two, it is easy for both monetary and fiscal policy to fall victim to data interpretation. Look for both Democrats and Republicans to use one or both to their advantage.  Whatever suites their agenda.

    Don't you just want to know how much your hard earned dollar can buy versus last quarter, or compared to last year?  Just what number are we to use?  Sua Sponte.

Bradford C. Bruner for Sua Sponte Wealth Management