To try to predict future market performance, US economist professor Robert Shiller established the CAPE® ratio – Cyclically Adjusted Price Profits – in 1988.
Then Professor Shiller later invented the Relative CAPE® ratio, which is a normalized CAPE® ratio that may be used to compare two sectors at the same time. The CAPE® ratio is divided by its mean value over the last 20 years to create this new indicator.
This ratio then became the basis for the Shiller Barclays CAPE® Sector index family.
The Shiller Barclays CAPE® Sector method begins by eliminating the five sectors with the highest Relative CAPE® ratios.
Then, from the remaining five, the sector with the worst momentum over the last 12 months is eliminated.
This phase in the index process is intended to avoid the so-called “value trap,” or the sector with the poorest recent market sentiment.
Here are some results from a backtest utilizing European equities
The five initially identified undervalued sectors outperformed the five that were rejected by an average of 2.46 percent; the momentum filter added another 2.58 percent to the five sectors that were eliminated. The index was successful in detecting periods of above-average performance in seven of the ten sectors.