Yale Professor Robert J. Shiller has a new piece examining the market up at The New York Times in which he notes that stocks are indeed expensive:
The United States stock market looks very expensive right now. The CAPE ratio, a stock-price measure I helped develop — is hovering at a worrisome level.
I wrote with some concern about the high ratio in this space a little over a year ago, when it stood at around 23, far above its 20th-century average of 15.21. (CAPE stands for cyclically adjusted price-earnings.) Now it is above 25, a level that has been surpassed since 1881 in only three previous periods: the years clustered around 1929, 1999 and 2007. Major market drops followed those peaks.
Unlike the standard way of valuing the market, based on trailing 12 month earnings, Shiller prefers to look at a smoothed out 10-year average of earnings to gain a long-term perspective, and to reduce the effect of the business cycle.
So while it’s true that the market is very expensive right now, based on his measure, he notes that it’s difficult to use this information to actually time the market. Just because it’s expensive, doesn’t mean it will go down. Furthermore, the market has been expensive based on his measure for the past 20 years (excluding the period of the recent crash), which raises the question of whether there’s been some fundamental change to the economy or markets that would warrant higher valuations.
Shiller’s piece examines some theories. One possibility is worker anxiety, and a higher inclination to put money into savings vehicles. He doesn’t give this tons of credence. Another possibility is interest rates, which have been low and going lower.
Ultimately, he thinks it’s simple:
…nothing I’ve come up with is a slam-dunk explanation for the continuing high level of valuations. I suspect that the real answers lie largely in the realm of sociology and social psychology — in phenomena like irrational exuberance, which, eventually, has always faded before. If the mood changes again, stock market investments may disappoint us.
And of course, the mood will at some point change.