Did Shiller Just Say US Stocks Are 30% Overvalued?

12th Apr '10 by Andrew Butter

2 comments 2404 reads

did Shiller just say US stocks are 30% overvalued? The headline on The Business Insider says that “according to Professor Shiller’s” website…"Stocks are 30% Over-valued". That story is now being picked up here and there. Read the small-print; notice they didn’t say that Professor Shiller “IS” saying that Stocks are over-valued. There is a difference.

The evidence for this “alarming” state of affairs is the Good Professor’s website, where you can go and look up his analysis, on an Excel spreadsheet that is helpfully in the public domain and kept up-to date. Shiller’s chart shows the ratio of what he calls the cyclically adjusted P/E ratio (CAPE) which is today’s price divided by the average of “Real” earnings (adjusted for inflation) over the past ten years.

TEN years!

The logic that says the Stock Market is 30% over valued is that “CAPE” today is 22, whereas the historical average of CAPE is 16.

If you read his lips, what Professor Shiller does say is price should bear some relationship to earnings, which is a perfectly reasonable and logical thing to say. What he does not say is that you can use CAPE as a sure-fire reliable tool to work out the “fundamental” value of the stock market. Neither does he come out on Prime-Time television, like for example Professor Roubini and periodically declare that the recent rally in the markets from the low in March 2009 was a “Dead-Cat-Bounce-Sucker-Rally”.

If you count Roubin’s calls on the stock market as part of his “record” for “getting it right”, he scores a hit rate of about 10% on his predictions, with about 30% proven to have been 100% wrong. Sure he predicted the credit crunch, but with a track-record like that, the snide remarks that some people make (not me) of “A Broken Clock is right twice a day”, are not totally unfair.

If Professor Shiller did do something like that, I would be the first to stand up and declare that he was dead-wrong. But (a) he did not and (b) he is a scientist, and like all scientists what he does is “Measure First” then “ Talk about it”, as opposed to what appears to increasingly pass for main-stream economics these days which is “Talk about you big new theory…

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emptyend

12th Apr '10

1: Efficient Market Hypothesis

The so far unproven “assumption” there is that collectively markets can figure out the “fundamental” value, and that any changes in the circumstances of the market-place are magically and instantly “priced in”. Apart from the fact that the body of evidence that markets are very often not efficient is, hugely, more than the evidence they generally are; that logic relies on the “assumption” that there is at least one person in the herd who knows what he is doing (and then the herd all follow him).

The Efficient Market Hypothesis will come to be shown as a triumph of groupthink over the real world - but only when the majority (and, yes, I do mean the majority....all the folks with index-trackers and other products that subsume the EMH) of people have lost substantial amounts of money.

It is my observation that the herd rely on herd instinct, rather than anyone in the marketplace ACTUALLY figuring out what the facts are and then acting rationally. Thus we have lots of people believing in things like TA and mean reversion of stock prices, making the bounce of the last year run and run......and aided by plenty of otherwise sensible people buying shares because "dividends pay more than cash in the bank or bonds". Sooner or later, this simple "weight of money rally" will stop....and people need to wake up and smell the coffee before that finally happens......

....so, whilst I wouldn't put a figure on it, I certainly think the market is overpriced given current circumstances of massive systemic global debt.......and I regard comparisons of any market metrics with their historical averages (etc etc) as dangerous hokum of the worst and most misleading kind! I am probably in a tiny minority with that opinion - but then I've been in a tiny minority many times before (including several times in public on bulletin boards) ....and events have often proven me correct (re Oil and banks, for example, as well as the FTSE fall in 2007/8).

ps...this piece in The Daily Telegraph is worth a read:

"The aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to the boiling point", said the [BIS]. Drastic austerity measures will be needed to head off a compound interest spiral, if it is not already too late for some....

"The question is when markets will start putting pressure on governments, not if. When will investors start demanding a much higher compensation for holding increasingly large amounts of public debt? In some countries, unstable debt dynamics -- in which higher debt levels lead to higher interest rates, which then lead to even higher debt levels -- are already clearly on the horizon."

Official debt figures in the West are "very misleading" since they fail to take in account the contingent liabilities and pension debts that have mushroomed over recent years. "Rapidly ageing populations present a number of countries with the prospect of enormous future costs that are not wholly recognised in current budget projections. The size of these future obligations is anybody's guess," said the report. The BIS lamented the lack of any systematic data on the scale of unfunded IOUs that care-free politicians have handed out like confetti.

Britain emerges in the BIS paper as an arch-sinner. The country may have entered the crisis with a low public debt but this shock absorber has already been used up, exposing the underlying rot in the UK's public accounts.

...though perhaps it should be in the "Gordon Brown Must Go" thread.....or whatever its more formal title is..

Andrew Butter

14th Apr '10

I think I agree with almost all of that except the part about debt and it's effect on the S&P 500.

The companies on the S&P 500 are not in debt, and also they pay 49% of the tax they pay to foreign governments in respect of producing goods outside of USA

There is another world that many don't see, outside of the flaccid self indulgence that comes from living beyond you're means

Did Shiller just say US Stocks Are 30% Overvalued?

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Andrew Butter

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