Research in Charts

StarCapital examines long-term relationships of capital markets and take advantage of these insights in its fund management. Selected internal research insights and their relationships are presented graphically.

Financial Pitfalls

Short-term forecasts, market timing and EPS estimations are just three pitfalls investors should be aware of.  The following charts focus on some rarely discussed fallacies in the financial markets.

Analysts’ short-term stock market forecasts: always positive, no predictive power

short-term stock market forecast - StarCapital - Keimling - Imkeller

Every year in December, well-respected banks publish their next year’s stock market forecasts. Investigating the relation of these forecasts and reality, it turns out that these elaborated forecasts don’t predict future performances better than most naive forecasts. For instance, banks forecasts weren’t more precise than assuming a constant yearly stock market return of 9%. This result remains true for every arbitrarily chosen return between 6% and 21%!

From our point of view, short-term performance is not predictable – hence, we renounce developing short-term predictions.

Poor market timing: misallocation burns wealth!

Market Timing - StarCapital - Keimling - Imkeller

Over the past 100 years, global equity investors generated real capital growth of about 7% annually. No other form of investment – whether bonds, cash, gold nor real estate – offers comparable return potential. Nevertheless and in spite of the persistent low-interest environment, German life insurance companies currently only invest 4% in equities. Furthermore, they turn out to be lousy market timer: having held the highest equity exposure in 2000 – just before the New Economy bubble burst – they sold stocks on unfavorable low price levels so that the portfolios still suffer from losses of two stock market corrections whereas the DAX 30 Index rapidly recovered from these losses and reached new highs.

Not financial crises but pro-cyclical regulation and poor market timing result in permanent wealth losses.

EPS estimations are subject to tremendous errors

EPS estimations - StarCapital - Keimling - Imkeller

The basic idea behind Discounted Cash Flow models is that a company’s value equals its discounted future earnings and cash flows. Unfortunately, even tiny misjudgments of the long-term earnings growth have a big impact on the resulting company’s value. Taken into account that the average error of analysts next year’s EPS forecasts since 1973 is 30%, nearly any company value – and hence any stock value – could be justified based on DCF models.

Thus, we avoid predicting short-term earnings.

Country Allocation

A reasonable country and sector allocation can be developed without short-term forecasts. The following charts focus on the relationship between fundamental valuations and the resulting long-term stock market potential.

CAPE as a reliable indicator for future long-term performance

Long-term S&P 500 CAPE - StarCapital - Keimling - Imkeller

Valuation ratios such as the cyclically adjusted Shiller PE (=CAPE) are strongly related to the long-term returns as exemplary shown in the S&P 500 since 1881. In this time, the CAPE has significantly exceeded its long-term average four times. Investors who invested in these overvaluations generally experienced real losses over periods of 10-20 years.

Details can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

Low valuations are followed by above-average stock market returns

Valuation Stock Market Returns - StarCapital - Keimling - Imkeller

Long-term stock market returns can be predicted from its valuation. The chart illustrates this relationship based on various indicators (Shiller-CAPE, price-to-earnings, price-to-book and price-to-cash-flow ratios, as well as dividend yield). Analyzing the period from 1979 to 2015, for all indicators, we found that low (=cheap) valuations were followed by higher long-term returns than high (=expensive) valuations. Therefore, investors should mainly invest in undervalued stock markets and avoid expensive markets.

Details can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

Which markets are currently undervalued?

Shiller CAPE PB Valuation Countries - StarCapital - Keimling - Imkeller

Between 1979 and 2015 we observed an average Shiller-CAPE of 18.3 and an average price-to-book (PB) of 1.8 in 17 MSCI country indices. Based on the assumption that these average valuation levels approximately represent a fair valuation level, Southern Europe and Emerging Markets are attractive whereas the US stock market significantly trades above its fair value.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

The fair value of German stocks over time

Fair Value Valuation Germany - StarCapital - Keimling - Imkeller

Based on these Fair Values computed by the historical average valuation levels, the German stock market currently trades close to its fair value whereas Southern Europe and Emerging Markets are undervalued. The US valuation is currently 41% higher than in the past.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

What long-term returns can investors consequently expect worldwide?

Long term Stock Returns Shiller CAPE PB - StarCapital - Keimling - Imkeller

By 04/30/2018, the US stock market's CAPE and PB are 29.8 and 3.2, respectively. During the last 130 years, comparable valuations only led to below-average annual returns of 3.2% for the following 10-15 years. With a CAPE of 20.2 and PB of 1.8, German stocks promise considerably higher returns. The highest long-term returns can be expected for the Emerging Markets.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

Which return-distribution follows from the current valuation?

Return Distribution Shiller CAPE PB - StarCapital - Keimling - Imkeller

The current US Shiller-CAPE of 30.3 was followed by average long-term returns between 0.8% and 4.6% on average in the past. Though, the range was huge so that long-term returns of -4.1% and 10.7% were seen. Attractive valuations in Russia and Brazil promise higher performances; historically, such valuations have never been followed by negative long-term returns.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

Example S&P 500: Which range of future returns can investors expect?

SP 500 Returns - StarCapital - Keimling - Imkeller

A long-term return estimation does not disclose any information about the range of returns investors may face during the next years. Like all predictions, stock market predictions based on fundamental value indicators are subject to a high degree of uncertainty. Taking the S&P 500 as an example, the chart shows the range of returns which investors had to face in the last 130 years with a comparable valuation during the subsequent 15 years. Based on the historical experience, with a probability of 80%, the S&P 500 will trade between 2,600 and 7,400 points in 2032 (with a probability of 50% between 3,400 und 5,300 points). Furthermore, levels in the range of 1,700 to 4,900 points in the next three years are likely.

In comparison, the German stock market offers a much higher return potential; DAX levels between 23,000 and 48,000 points in 2032 are likely.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

Attractively valuated countries outperformed expensive countries in 2017

Outperformance Undervaluation Countries - StarCapital - Keimling - Imkeller

Based on the December 2016 valuation ratios, the 15 most attractive countries based on CAPE led to a mean return of 24%. The highest growth rates were seen in China (+52%), Turkey (+49%) and Hong Kong (+35%). With an average return of 16%, the return of the 15 most expensive countries were considerably lower. This also holds true for the PB. Will this trend continue in 2018?

High valuations also indicate higher downside risks

Downside Risk Shiller CAPE PE PB DY - StarCapital - Keimling - Imkeller

Valuation levels do not only forecast future long-term returns but also indicate impending downside risks. From 1979 to 2015, attractive valuations were followed by lower price declines than high valuations, as displayed in the chart. For all indicators under consideration, divided into five quintiles, the chart shows the maximum losses investors could have suffered if they had sold at the worst point in time. Under these circumstances, the downside risk of stock markets increase with rising valuation levels. Thus, also seen from a risk perspective, investors should avoid expensive stock markets.

Details can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

However, structural changes may impair Shiller-CAPE's validity...

Greece Structural Change Impair Shiller CAPE - StarCapital - Keimling - Imkeller

Not every attractive valuation necessarily leads to a buy opportunity. Especially, the cyclically adjusted Shiller-CAPE shows considerable shortcomings in markets with structural changes, such as changes in index composition. For example, it is not very meaningful to calculate the CAPE for the MSCI Greece, where the number of stocks varied from 2 to 22 during the last 10 years and the average earnings are based on a no longer existing financial sector. Thus, the CAPE should mainly be used in larger indices with stable compositions.

...also different sector compositions impair comparisons between countries

Sector Adjusted Shiller CAPE PB PE PC PS Denmark - StarCapital - Keimling - Imkeller

Apart from structural changes, other factors can impair the comparison among countries. Considering Denmark, the chart illustrates the effect of differing sector weights and suggests possible adjustments for valuation ratios. The Healthcare sector is represented in the MSCI Denmark with a weight of 45%, whereas the MSCI World invests only 9% in this sector. This leads to drastic consequences in the valuation: with an average PB of 4.5 since 1995, Healthcare-stocks were valued about 90% higher than other sectors. Can an index with a weight of 45% in such expensive sectors ever get to a neutral valuation level?

Can the US-overvaluation also be explained by its high Technology weight?

Sector Adjusted Shiller CAPE PB PE PC PS USA - StarCapital - Keimling - Imkeller

Also the overvaluation of the US stock market has to be relativized a little if differences in sector compositions are taken into account. Measured by PB, the US market trades at a valuation premium of 52% compared to the global stock market. By taking into account that the US market is strongly invested in the expensive Technology sector, a sector adjustment decreases the overvaluation. However, even with adjusting, a significant overvaluation of 30% remains.

Is the US overvaluation just due to the normal US value premium?

Relative Valuation USA - StarCapital - Keimling - Imkeller

The US market is not only overvalued compared to other stock markets and its own history, but also the magnitude of this overvaluation has rarely been higher than today. From 1979 on, on average, investors had to pay 36% higher prices for US stocks compared to European stocks. Currently, this premium is approximately 60%.

US-stocks: dangerous triad: overvaluation, euphoric sentiment and carelessness

US Overvaluation Euphoria Carelessness - StarCapital - Keimling - Imkeller

In the long run, the prospects look bad for US investments. After years of price increases, the US market is highly overrated, the low volatility level leads to carelessness and the sentiment is euphoric as never before. However, historically, the biggest price gains occurred after crises, i.e. after phases of attractive valuations, high uncertainty and pessimistic sentiment. Contrarian investors can find more promising alternatives here.

Country weight in MSCI AC World versus GDP

MSCI Weight - StarCapital - Keimling - Imkeller

A country's share of global GDP may significantly deviate from its weight in a worldwide stock index. For example, China represents 15% of worldwide GDP but only 4% of MSCI All Country (AC) World Index. Remarkably, the overrepresented US market (53% MSCI weight vs 25% GDP weight) shows a similar gap as Japan in 1989 at the peak of the stock market bubble when Japan represented 44% of the world stock market but only 16% of worldwide GDP. In the meantime, the index and GDP weight of Japan converged.

Factor Investing

After identifying attractive countries and sectors, the question arises how to invest in a meaningful way. As numerous studies have proven before, some factor strategies outperform their benchmarks in the long-run, which the following charts will demonstrate.

The value comeback is overdue: US value premium since 1926

USA Fama French HML Value Premium - StarCapital - Keimling - Imkeller

Academic research provides evidence that the outperformance of value stocks (HML) towards growth stocks in the long-run is subject to substantial cycles. Whereas only seven periods of significant value underperformance have emerged since 1931, the current period is lasting for an unprecedented time of 7 years by now. However, these periods were followed by 12 years of value outperformance on average.

Can value strategies be optimized by considering momentum indicators?

Combining Value Momentum - StarCapital - Keimling - Imkeller

A fundamental undervaluation does not indicate when stock prices will rise. In fact, value-investors tend to invest too early, and often buy stocks that continue to depreciate. An undervaluation of a company is worthless until other investors recognize the undervaluation and begin buying the stock, causing its price to appreciate. Thus, momentum indicators can improve investment timing which is backed by our research results.

StarCapital - Norbert Keimling

Contact Us

For queries or additional information please contact:


Norbert Keimling
Head of StarCapital Research
info(at)starcapital.de