No. of Recommendations: 2
That does seem to be the reasoning here. They successfully tried to find a way to dampen the true earnings impact of recessions, removing the precise goal of CAPE in the first place. Recessions are SUPPOSED to drag down the earnings for years after, that's what the smoothing is for. Some of the low earnings during recessions appear as lower gross margin, and some of it appears as losses. Some of the losses are write-downs of previously reported earnings that turned out not to have been real. It's all part of the cycle and should always be counted.<iI>
I think the reason for the adjustment is that Shiller designed the CAPE prior to SFAS 121 / ASC 350. In the old days, economic losses were recognized gradually.
Today, accounting standards force companies to do impairment tests and dump massive, multi-year non-cash losses into a single quarter. Because Shiller's CAPE
uses trailing GAAP earnings, these massive, concentrated accounting charges drag down the 10-year average far lower than the actual operational cash flow of the
index warrants. Because these write-downs are backward-looking and heavily bunched into single years, they destroy the model's ability to forecast what the index
will actually earn over the next decade.
