Credit SuisseAndrew GarthwaiteThe Shiller P/E ratio, or the cyclically-adjusted price-earnings ratio, is one of the most popular yet most misused measures of stock market value.
It’s calculated by taking the S&P 500 and dividing it by the average of 10 years worth of earnings.Â If the ratio is above the long-term average of around 16, the stock market is considered expensive.
Currently, the Shiller P/E is at 24.
While this certainly looks expensive, it would be a mistake to assume that stocks are doomed to crash until the ratio rights itself.
“We recognise that some investors are concerned that absolute valuations for US equities are at elevated levels,” says Credit Suisse’s Andrew Garthwaite in a new note to clients. “This is the certainly the case on the Shiller P/E. However, we find current multiples have not necessarily been a pre-cursor of falling markets. We note that markets are typically most vulnerable when the Shiller P/E is above 26x (compared to 24x currently).”
Garthwaite forecasts the S&P 500 to head to 1,900 by the end of next year.
Here’s a chart from Garthwaite that we’ve seen before. It shows the average three annualized returns given each level of the Shiller P/E.