Robert Shiller: Valuation levels a worry

Stockmarkets have rarely been more expensive than they are today, reckons Professor Robert Shiller, the man behind the Cape ratio.

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".

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Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri