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What Does High CAPE Ratio Mean for ETF Investing?

Overvaluation worries have been glued to the latest equity market rally. No matter how highs U.S. markets have hit lately, stock market gurus are more concerned about the lack of 5% declines in the market—“an occurrence that isn’t unusual in a normal market environment,” as per an article published on MarketWatch (read: Dow at Record High: More Upside for ETFs?).

The S&P 500 has spent over 265 days not seeing a correction of 5% or more and marked its longest winning streak in 20 years. The Dow hasn’t seen a 5% slide since 2011, and prior to that a 5% decline was witnessed in 2008. The CBOE Volatility Index plunged to a record low. So, chances of a pullback in an already inflated market are always there.

Market Complacency Worrying Robert Shiller

As per billionaire investor Howard Marks, “the Shiller Cyclically Adjusted PE Ratio, known as the Shiller CAPE, is at its highest level since only two other times in the market’s history.” Just before the Great Depression in 1929, and mid-1997 to mid-2001 saw the CAPE ratio at higher levels than we are in now.

Current CAPE or Shiller PE Ratio for the S&P 500, which is the average inflation-adjusted earnings from the previous 10 years stands at 30.30 times. The metric is at 80.7% premium to the mean Shiller PE Ratio of 16.77 times. This high number, in the absence of materialization of most of the pro-growth promises made by Trump, calls for a correction in the near term.

In fact, the inventor of the ratio – Nobel laureate Robert Shiller – issued warnings for investors. He believes that price increase go hand in hand with earnings increase. But the latest market behavior seems to be “an overreaction to good earnings” to Shiller. The ongoing complacency in the market is probably the lull before the storm.

As per CNBC, if Shiller turns right this time as he was about predicting the dot-com bubble and the housing bubble, the U.S. stocks are likely to see a correction. Same was the view of Jeffrey Gundlach's DoubleLine Capital, which bought “some five-month put options on the Standard & Poor's 500 Index” as the CBOE Volatility Index is “ridiculously low” (read: Will Gold ETFs Shine in August?).

SPY’s & SPLV’s Volume Patterns

In fact, investors seem to have moderate faith in the recent rally as volume is still not quite upbeat. Most rises in SPDR S&P 500 ETF (SPY) have been supported by weaker trading volumes. But activity remained pretty strong in PowerShares S&P 500 Low Volatility Portfolio ETF SPLV in recent times (read: Low Volatility ETFs in Fine Fettle Despite a Bull Market).

We thus highlight a few low-volatility ETFs that could interest edgy investors.

Barclays ETN+ Shiller CAPE ETN CAPE

The product isa senior, unsecured debt security, linked to the performance of the Shiller Barclays CAPE US Core Sector Index. The index looks to provide a notional long exposure to the top four relatively undervalued U.S. equity sectors that display relatively strong price momentum.

iShares Edge MSCI Min Vol USA ETF USMV

The underlying index measures the performance of equity securities in the top 85% by market capitalization of equity securities listed on stock exchanges in the U.S. that have lower absolute volatility. The fund charges 15 bps in fees.

SPDR Russell 1000 Low Volatility ETF LGLV

The SSGA US Large Cap Low Volatility Index is designed to track the performance of U.S. large capitalization companies that exhibit low volatility. The fund charges 12 bps in fees.

PowerShares S&P 500 Low Volatility Portfolio ETF SPLV

The underlying index comprises 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months (read: New Active Low Risk ETF from Cambria).

Fidelity Low Volatility Factor ETF FDLO

The index measures the performance of stocks of large and mid-capitalization U.S. companies with lower volatility than the broader market.

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POWERSH-SP5 LVP (SPLV): ETF Research Reports
 
FID-LV FACTOR (FDLO): ETF Research Reports
 
ISHARS-MS US MV (USMV): ETF Research Reports
 
SPDR-R1000 LV (LGLV): ETF Research Reports
 
BARCLY-ETN SC (CAPE): ETF Research Reports
 
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