Robert Shiller: Valuation levels a worry

Professor Robert Shiller of Yale University is worried about valuation levels. Judging by the cyclically adjusted price/earnings ratio (Cape), the valuation measure he helped to popularise, US stockmarkets have rarely been more expensive than they are today. The Cape (or Shiller p/e) shows how pricey stocks are compared with average earnings over ten years. Higher Cape levels are a pretty reliable indicator of lower future stock returns. Indeed, if the Cape’s forecasting power holds up, Shiller reckons that investors should expect real (after-inflation) returns of about 1% a year over the next decade.

Even so, he wouldn’t suggest that you give up on stocks completely. After all, the Cape ratio has been at historically high levels for the past 20 years (with a few rare exceptions), and the market isn’t yet as overvalued as it was during the tech bubble of 2000. So while the market is “high enough to make me nervous”, Shiller isn’t predicting “imminent disaster”. And holding even a small quantity of shares can provide diversification benefits for investors.

After a career in economics, Shiller believes the subject is “as much about Sigmund Freud as Paul Samuelson” (a Nobel Prize winner and author of a key textbook). “Animal spirits” play a big role in driving consumer demand and asset prices. So even if Donald Trump doesn’t cut taxes or slash regulation, he can still act as a “motivational speaker for the market”. In the short run at least, the president will keep driving prices higher by boosting consumer and investor confidence. In the long run, this may not be enough. What’s more, there is a good chance that Trump’s “quixotic personality” will “create a crisis”.

  • Kevin Hoque

    As real interest rates have dropped, over the past 20 years, asset prices have risen. This relationship is hardly surprising. The natural level of Cape will thus be higher during periods of low (or negative) real interest rates. Historical comparisons of Cape, without taking this into account, may not be so helpful. Stock markets probably are much where we would expect them to be given central bank monetary policy. Just some Sunday morning thoughts..


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