When asked if stocks are overvalued, Nobel laureate Robert Shiller supplies a simple answer: “yes.” But that doesn’t mean equities are set to dive.
Evidence that stocks may be richly priced is easy to find. Shiller’s cyclically adjusted price-to-earnings ratio, which compares the current value of equities to inflation-adjusted earnings over the past 10 years, is at levels not seen except for the years surrounding 1929 and 2000. And at 29, the ratio is higher than its highest level before the Great Recession.
Still, Shiller makes it clear this doesn’t necessarily suggest that investors should sell stocks.
“I’m not saying pull out of the market — I’m saying that it looks dangerous now,” the Yale economics professor said Wednesday on CNBC’s “Trading Nation.” “But it could keep going up.”
After all, “if you go back to 1998, you’ll find that the CAPE ratio was about the same as now, and it kept going up for two more years. It got up to something like 45 in the year 2000. So we could go back up there. And we’re in an oddball-enough mood now that we might,” Shiller said, referring to excitement surrounding President Donald Trump.
“The magic of the Trump story is that it gets stronger than any other news. It pushes everything else aside, partly business people identify with Trump [and have] an urge to gamble on this guy,” he told CNBC in a phone interview.
While Trump is rarely likened to the man known as “Silent Cal,” Shiller finds the historical comparison useful.
“I’m reminded of Calvin Coolidge, who become president in 1923, and the market started going up, and there were people saying that valuation ratios were getting too high — for years! Eventually, as you may have heard, it crashed.”
A further rally followed by a crash, then, is certainly a potential outcome. Although as Shiller also makes clear, investors shouldn’t obsess over the level of the CAPE ratio.
“The idea that these ratios represent forecasts for the underlying value is just not right,” he said. They mostly shed light on “psychological narratives.”
In addition, some have questioned the CAPE ratio’s usefulness in a period of prolonged low interest rates and evolving accounting standards. Still, most valuation metrics do show that stocks are relatively expensive as compared with historical precedents.
So where does that all leave investors?
“I don’t like to worry too much,” Shiller said. But “it’s a good time to look at one’s portfolio and ask if it’s diversified enough.”
—Additional reporting contributed by Stephanie Landsman.