Changing Times, Changing Values: A Historical Analysis of Sectors within the US Stock Market 1872-2013

Abstract

We construct a price, dividend, and earnings series for the Industrials sector, the Utilities sector, and the Railroads sector from the beginning of the 1870s until the beginning of the year 2013 from primary sources. To infer about mispricings in the sector markets over more than a century, we investigate the forecasting power of the Cyclically Adjusted Price-Earnings (CAPE) ratio 1 for these sectors. With regard to the CAPE ratio, which has originally been devised and employed by Campbell and Shiller (1988, 1998, 2001) as well as Shiller (2005), we define a methodological improvement to this ratio to not only be robust to inflationary changes, but also to changes in corporate payout policy. We then update the original evidence from Campbell and Shiller (1998, 2001) of the return predictability of the CAPE ratio for the overall stock market and furthermore extend this evidence to the three aforementioned sectors individually. Whereas this part of our analysis focuses on each sector of the US economy in isolation, we subsequently construct an indicator from the CAPE ratio that enables us to perform valuation comparisons across sectors. In addition to establishing the prediction of subsequent return differences based on differences in the CAPE-based valuation indicator, we also suggest a hypothetical, historical, and simple value investment strategy that rotates between the three sectors based on the valuation signals derived from the CAPE-based indicator, generating slightly more than 1.09% annualized, inflation-adjusted excess total return over the market benchmark during a period of nearly 110 years.

The Shiller CAPE Ratio: A New Look

“…The higher the growth rate of real earnings, the lower the average of the past 10 years of earnings relative to current earnings-which raises the Acknowledging that a change in dividend policy affects the CAPE ratio, Bunn and Shiller (2014) neutralized its impact by constructing the CAPE ratio of a total return portfolio (TRP). The TRP assumes that all dividends are reinvested in the index and that the TRP's earnings per share are the index's earnings per share times the number of shares in the TRP-what Bunn and Shiller termed the "scale-adjusted earnings per share."…”

Monetary Policy, Redistribution, and Risk Premia

“…The remaining series are from CRSP.20 The smoothed dividend-price ratio is the 3-month moving average of dividends divided by the price of the stock at the end of the month, value-weighted over the S&P 500. We linearly detrend this series given changes in corporate payout policy over the sample period (seeBunn and Shiller (2014)).…”