ROBERT SHILLER: It's Time To Be Worried About Stocks, But I'm Not Bailing Out

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robert shiller

PBS Newshour

Robert Shiller

Robert Shiller's famous stock market valuation metric - the cyclically-adjusted price-earnings (CAPE) ratio - is at 25.4x right now.

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CAPE is calculated by taking the S&P 500 and dividing it by the average of ten years worth of earnings. If the ratio is above the long-term average of around 16x, the stock market is considered expensive.

Relative to the long-term average, 25.4x seems extraordinarily high. And some folks think this is a great reason to dump stocks because it appears the risk of a crash is high.

But who's not dumping stocks?

Robert Shiller. And he won the Nobel Prize in Economics for his related work.

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Here's a quote from a recent PBS interview we saw on Brad Delong's blog:

Paul Solman: But the index to which you refer, the cyclically adjusted price earnings ratio, that's at about 25 at the moment. It peaked at 45 back in 2000. In 1929, it was about 35, but historically the average is somewhere like 15, 16? So 25 to 15 is overvalued by 60 percent.

Bob Shiller: It can keep going up. Even so, it's not a clear signal yet. Well, 25... it could go up to 35, easily.

Paul Solman: And then you'd have left a lot of money on the table by not having bought at 25.

Bob Shiller: That's the problem that... yeah, it's time to be worried, but it's not necessarily time to bail out. I have money in the stock market. I would say it's about 50 percent, but I don't have the exact number. And I don't think it necessarily means that I'm a model for everyone. I'm someone who is older, and young people can take greater risks. I'm not advising them to, but it's natural that they might.

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There's a few things Shiller is communicating here.

First, he reminds us that momentum or irrational behavior or some other unidentified phenomenon can cause market valuations to swing big before reverting back to a mean. That's why he thinks the CAPE could conceivably go to 35, which would put the S&P 500 at close to 2,500.

Second, Shiller reminds us that the CAPE model is not good for timing the market, a point he's reiterated in the past repeatedly. Rather, he emphasizes that CAPE is only decent at predicting long-term returns. And according to Credit Suisse's Andrew Garthaite, current CAPE levels correspond to mid-single digit intermediate-term returns.

Ultimately, you can argue that the CAPE reflects an expensive market. But Shiller would advise against using it as a tool for predicting imminent stock market crashes.

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