Why would highly intelligent investors like Rob Arnott and Jeremy Grantham assign so much credence to a metric that contains major flaws? It's a metric that flashed a sell signal in May 2009, perhaps the best time to buy stocks since the early 1980s.

We're talking about Robert Shiller's cyclically adjusted price-to-earnings (CAPE) ratio, for which the Yale University economics professor won a Nobel economics prize. Speaking at the ninth annual Inside ETFs conference, Wharton School of Finance professor Jeremy Siegel analyzed equity market valuations in depth and gave particular attention to Shiller's CAPE ratio.

Siegel is not the only savant to question whether this metric should be viewed with the reverence some treat it, but he cited some powerful evidence why it can be misleading. Between 1981 and 2015, the CAPE ratio signaled that equities were overvalued in no fewer than 416 of 422 months.

During his talk, Siegel explained in detail some of the issues surrounding the Shiller P/E, acknowledging that he and Shiller got their doctorates at MIT together and have been good friends for 50 years. Siegel noted that he will publish an article on the subject in the Financial Analysts Journal, raising serious skepticism about the measure in the next month or so.

It's difficult to overstate the reverence with which many world-class investors view the Shiller P/E. When Shiller shared a Nobel prize in 2013 with University of Chicago professor Eugene Fama, who conceived the efficient market hypothesis, Grantham wrote a piece extolling Shiller while questioning whether Fama deserved it.

At the ETF event, Siegel turned to the equity market and remarked that if many other observers, including speakers at the conference, tended to be bearish, he was not. "I'm the token bull," Siegel joked. "From what I heard the other speakers here [say], I decided to apply for endangered species status."

One of the key flaws in the Shiller P/E was no fault of Shiller. In 1990, Standard & Poor's, following the Financial Accounting Standards Board, changed the definition of GAAP (generally accepted accounting principles) earnings to require mark-to-market accounting.

But the change in criteria only required that companies mark down their assets when they have a loss. When an asset increased in value, it could only be marked up when it was sold. "That's not Bob's fault," Siegel said.

Many sophisticated investors consider the Shiller P/E a very useful measurement but one with obvious limitations. The statistical calculation averages P/E ratios over 10 years to smooth out cyclical swings. DoubleLine Capital has created a smart beta fund, the DoubleLine Shiller CAPE-Enhanced Equity Fund, that was the top-performing large-cap value fund in 2014 and enjoyed stellar returns in 2015.

But its predictive powers and limitations surfaced notably in the last decade. In 1999 and 2000, the prices of certain stocks reached absurd levels, and Shiller's proved an excellent indicator. Then in the 2008-2009 period, corporate earnings collapsed and P/E ratios soared.

The events, almost polar opposites, occurred twice in the same decade. That largely explains why the Shiller P/E indicated equities were overvalued in May 2009. Advocates of the Shiller P/E will say it really happened. Trying to explain historical experience away sounds a bit like the hedge fund salesman putting the spin on why his manager underperformed the S&P 500 for five consecutive years whie taking excessive risk.

Turning to current equity market conditions, Siegel said that stocks were only slightly overvalued from historic norms, and that high P/E ratios were normal in a period of very low interest rates. Over the last 60 years since 1954, the median P/E ratio (not the CAPE ratio) has been 16.8. "We're a little above that, but not much," he said.

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