Tags: O’Neill | stocks | PE | Shiller PE

Goldman Sachs’ O’Neill: Stocks Are ‘Hardly Bargain Basement’

By Michael Kling   |   Tuesday, 12 Mar 2013 12:03 PM

Stocks are becoming overvalued and may be approaching a dip, warns Jim O’Neill, chairman of Goldman Sachs Asset Management.

“They are hardly bargain basement these days from a CAPE [cyclically adjusted price-earnings ratio] perspective,” O’Neill wrote in a note obtained by CNBC.

CAPE, also known as the Shiller P/E, is the stock price divided by average earnings over 10 years, adjusted for inflation, and is often used to smooth out earnings over long periods.

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While stocks might rise in the near term, O’Neill is cautious about the long term.

“I am not that confident about what happens next and as to whether all these trends are going to continue, not least because May is now less than two months away and the infamous ‘Sell in May and go away, come back on St. Leger’s Day,’” he said, referring to an old saying that advises investors to sell in May, according to CNBC.

The Shiller P/E ratio was 23.8 for Standard & Poor’s 500 companies as of Thursday, according to the International Business Times. That compares with a mean ratio of 16.46 and a median of 15.87, indicating that stocks are overvalued.

The highest Shiller P/E was 44.2, reached in dot-com bubble in 1999, the Times noted. The lowest was about 4.8 in 1920 just before the start of the roaring ‘20s bull market. The ratio rose to 9.7 by the beginning of 1925, and then went to 11.3 in 1926, 13.2 in 1927, and 18.8 in 1928, and 27.1 in 1929. After the crash of 1929, the Dow Jones Industrial Average didn’t regain its pre-crash level until 1954.

P/E ratios over 20 indicate that stocks are overvalued, according to the International Business Times. However, periods of overvaluation can last for many years.

Given the stock market’s history of volatility, investors should be able to tolerate a 20 percent drop in stock values and have the patience to wait and hold stocks during market corrections.

More cautious investors should use dollar-cost-averaging or investing smaller amounts over time as opposed to lump sums, and should stick with quality companies with solid histories and established markets.

Editor's Note: The Final Turning Predicted for America. See Proof.

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