Outlook improves for long-term investors

The near-term outlook for stocks is murky, but long-term investors may have reason for cheer.

The Cape, or cyclically-adjusted price-earnings ratio, is the preferred valuation metric used by many long-term investors. One-year price-earnings ratios can be unreliable due to the volatile nature of corporate earnings. In contrast, Cape averages earnings over a 10-year period, smoothing out the highs and lows of the economic cycle.

Heavy market falls mean the Cape has cheapened in all major regions this year, notes Barclays, but regional disparities abound. The US Cape ratio, for example, is 29.9 – much lower than six months ago, but still well above long-term norms.

In contrast, the MSCI Europe index has cheapened back to its long-term average, trading on a Cape of 18.6. That suggests European stocks are priced to generate annualised returns of 7.9 per cent over the next five years.

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Even in Europe, however, valuations vary widely. UK and French stock returns should mirror the aforementioned pan-European returns, but Italian stocks are expected to return just 2.9 per cent annually over the next five years.

In contrast, Germany’s Cape ratio is well below its long-term norm, with Barclays estimating annualised stock returns of 11.7 per cent over the next five years.