Tags: Shiller | explanation | stocks | valuations

Shiller: No 'Slam-Dunk Explanation' for Lofty Stock Valuations

By Dan Weil   |   Monday, 18 Aug 2014 05:20 PM

The cyclically-adjusted price-earnings (CAPE) ratio formulated by Nobel laureate economist Robert Shiller shows that the S&P 500 stands at its fourth-highest valuation since 1881, but there's no easy answer as to why, he says.

The CAPE ratio, which is based off average earnings of the last 10 years, stands at 26.1, a level that was bested only in the periods around 1929, 1999 and 2007, going back to 1881. Those three periods, of course, saw stocks crash.

The measure now signals danger, Shiller writes in The New York Times. "Still, the ratio has been a very imprecise timing indicator. It’s been relatively high — above 20 — for almost all the last 20 years, with the exception of 20 months."

Editor’s Note: 5 Shocking Reasons the Dow Will Hit 60,000

So why are stock prices so high? "Nothing I’ve come up with is a slam-dunk explanation," Shiller says.

"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."

But MarketWatch columnist Brett Arends sees a good chance the five-year bull market will continue, at least for the time being. Three factors "suggest" further gains, he says:

1. "Absolutely everybody seems to be predicting a crash this autumn," Arends writes. "When everybody is saying the same thing, they are often wrong."

2. Retail investors sold stocks in a panic last month. "History has shown, alas, that Mom and Pop are absolutely terrible market timers," Arends says.

3. A Bank of America Merrill Lynch survey shows that money managers have turned more bearish toward stocks, a contrarian indicator.

Editor’s Note: 5 Shocking Reasons the Dow Will Hit 60,000

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