Its time to put the Shiller PE ratio to the test. As mentioned in my previous blog, Shiller calculates a special PE ratio which he calls P/E10. He defines this ratio as price divided by the average of ten years of earnings (a moving average) and adjusted for inflation. Price refers to the index level of the S&P 500 index, and earnings are those of the 500 constituent stocks.
The PE15 trading rule is a contrarian strategy that buys the index when the PE is below 15 and is out of the market when the PE is above 15. It is an active strategy compared to the buy-and-hold (BH) strategy. In this blog, I will compare the profitability of the PE15 strategy with that of the passive BH strategy. The winner is the strategy that produces the highest compounded or terminal value, starting with an investment of $1.
My data is obtained