Thomas K Philips, Adjunct Faculty, Department of Finance and Risk Engineering, Tandon School of Engineering, NYU
– 28 July 2023
Robert Shiller’s cyclically adjusted price/earnings ratio (CAPE) has proven to be a powerful descriptor, as well as a useful predictor, of long-term equity returns in the United States and many global markets. CAPE uses a 10-year average of real earnings to simultaneously filter noise in earnings and to estimate corporate profitability over a business cycle. In this talk, Thomas K Philips explained CAPE’s theoretical underpinnings and simplified its methodology by separating the filtering of noise from the detection of cyclicality in earnings. In addition, he accounted for an empirical nonlinearity in the relationship between valuation ratios and equity market returns and combined two robust non-linear forecasts to create an improved forecast of the 10-year forward returns of the S&P 500. He also explained why robust estimators are of particular importance in finance, and why so many predictive models perform poorly out-of-sample.