Stocks look dangerously close to a bear market, but that doesn’t mean it’s time to sell everything, according to the Nobel-winning author Robert Shiller.
In a post on Project Syndicate Thursday, Shiller said the cyclically adjusted price-to-earnings ratio he helped develop was useful in predicting returns over the next decade. The gauge values stocks based on the past 10 years of earnings to smooth out periods when growth or weakness was abnormal.
In the peak months before bear markets — widely defined as declines of 20% or more — the CAPE ratio was above its average of 22.1. On Friday, it was slightly above 30.
The market’s inactivity is also a reason to be wary, Shiller said. Stock-price volatility was lower than average in the year leading up to the peak month before all of the last 13 bear markets, Shiller wrote. It’s currently lower than the 3.1% average for the time frame including those bear markets.
Does this mean that a bear market is imminent? Shiller says no.
“Such episodes are difficult to anticipate, and the next one may still be a long way off,” he said.
Still, this “analysis should serve as a warning against complacency,” Shiller said. He continued: “Investors who allow faulty impressions of history to lead them to assume too much stock-market risk today may be inviting considerable losses.”
Uncertainty around when the next bear market could come is partly why most strategists at major Wall Street firms are reluctant to turn bearish even as they continuously warn that stocks are overvalued. The median year-end S&P 500 forecast among strategists tracked by Bloomberg is 2,500, implying a nearly 12% gain for the market in 2017.
They wouldn’t want clients to miss out on the late stages of the bull market, which is typically when returns are the highest. Also, double-digit earnings growth and an economy nudging a 3% growth pace are attractive.
That doesn’t take away from the fact that stocks are overvalued. But this fact alone is not a reliable buy or sell signal, according to Laszlo Birinyi, the president of Birinyi Associates, who was one of the first to nail the current bull market.
Here’s how he recently put it to Business Insider’s Joe Ciolli (emphasis added):
“We can catalogue a bunch of articles [on the Shiller CAPE ratio] that show no one’s ever said to buy. It’s always been ‘the market’s overpriced,’ ‘the market’s expensive,’ ‘the market’s high,’ but no one’s ever said buy. In July 2009, there were some articles saying that according to some valuation measures, the market was fully valued. In July 2009! To me, something that’s never told me to buy is not something I’m going to listen to when deciding when to sell.”
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