Star Yale University economist Robert Shiller says stock prices are overvalued based on price-earnings data, while Bank of America Merrill Lynch strategist David Bianco takes the opposite view.
The Wall Street Journal outlines the duo’s competing views. “Which side you take depends partly on whether you are more comfortable with the analysis of an academic who works far from Wall Street and whose job is to test theories, or a Wall Street strategist who is paid to track the market closely and bring in business,” the Journal states.
Shiller rose to fame by predicting the stock market crash in 2000 and the more recent housing bust.
|Robert Shiller (Getty photo)
Shiller's price-earnings analysis differs from most Wall Street analysts, because most of them simply use the previous year's profits, or analysts' predictions of future profits, in formulating the earnings side of the ratio.
Shiller instead uses the average of company profits for the prior 10 years. That obviously gives a broader picture, eliminating distortions from short-term factors.
Using that measure, Shiller calculates that the Standard & Poor’s 500 stocks trade at 23 times earnings, greatly exceeding the historical average of 16.
Bianco begs to differ, saying Shiller's data are inaccurate. By his calculations the S&P 500’s PE ratio now stands at 14.5.
While Shiller uses the standard definition of earnings – net income – Bianco uses operating earnings, which exclude all kinds of different write-offs. Taking out these write-offs, of course, pushes earnings higher, making the PE ratio lower.
Bianco makes another adjustment to push earnings higher, noting that companies have held on to a higher percentage of profits in recent decades, paying lower dividends. Retaining more earnings for investment indicates a potential for faster profit growth that isn’t reflected in reported earnings, Bianco argues.
Finally, he compares current PE ratios only to levels prevailing since 1960, as they have risen higher during that period than in the past, making today’s comparisons more benign.
"Clients call it the Bianco method vs. the Shiller method," Bianco told the Journal. "People call it Wall Street vs. the universities, or the Ivory Tower vs. the Bank of America Tower."
Shiller was apparently unaware of such a rivalry. He told the Journal he didn’t pay attention to Bianco's work until the newspaper asked. Shiller went back over his data in light of Bianco’s criticism.
The professor’s conclusion: "The basic analysis I have been presenting is right as is."
After the global financial turmoil of recent weeks, Shiller isn’t the only one casting a wary eye on stocks.
“Every day, the price of oil marches higher, and it’s surprising the equity markets aren’t reacting even more negatively,” Mark Luschini, chief investment strategist at Philadelphia-based Janney Montgomery Scott, tells Bloomberg. “Commodities are rallying across the board,” adding to inflation concerns, he said.
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