Economist Robert Shiller was one of three Americans to be awarded
the Nobel Prize in Economicsthis morning.
Shiller is well known in the investing community for his namesake valuation ratio: the Shiller P/E, aka the cyclically-adjusted price-earnings ratio (CAPE).
CAPE is calculated by taking the S&P 500 and dividing it by the average of 10 years worth of earnings. If the ratio is above the long-term average of around 16, the stock market is considered expensive. Shiller has argued that the CAPE is remarkably good at predicting returns over the period of several years.
In his book Irrational Exuberance, Shiller argued that CAPE signaled a bubble in the stock market. The book was published in March 2000. And soon after, the dotcom bubble burst.
And today, many investors swear by Shiller’s CAPE ratio.
But in an April 2012 interview with Money Magazine, Shiller said something stunning.
“Things can go for 200 years and then change,” he warned. “I even worry about the 10-year P/E — even that relationship could break down.“
Even considering that risk, Shiller has consistently argued that stocks have looked more attractive than bonds and housing.
While Shiller’s CAPE may eventually break down, for now, it’s held up.