Are Stocks Are Overvalued?

Matt O’Brien writes at Wonkblog:

Now, stocks have cooled off since the start of the year, but not that much. So does that mean stock prices are “quite high”? Well, that depends on how you look at it. Take Robert Shiller’s cyclically-adjusted price-earnings ratio, or CAPE, which looks at the past ten years of earnings to figure out how pricey stocks are today. The idea here is that it smooths out any big ups or downs, and shows us how fairly valued—or not—stocks are. And by this measure, as you can see below, stocks really are getting expensive.

The only problem is they’ve been getting expensive for awhile low. “According to CAPE,” Crossing Wall Street’s Eddy Elfenbein told me, “stocks have been valued above average for most of the last 25 years.” Part of that is accounting standards are different than they used to be, so valuations are too—they’re higher. Another part is that interest rates having been falling the last three decades, and, all else equal, lower rates should mean higher stock valuations. And the last part is that CAPE overweights what happened before to what’s happening now. Think about it like this. Today’s 27.2 CAPE ratio is so high, in part, because earnings were so bad during the financial crisis. But it’s a little funny to say that a historically crummy economy seven years ago means stocks are overvalued now.

Another way to look at this is to just consider last year’s earnings. Now this has the opposite problem of only weighting what’s happening now. So if earnings are negligible or negative, like they were in 2008, this will say that stocks are super expensive when they’re actually super cheap. But as long as we keep that in mind, this still helps us look at stocks from a slightly different angle. And it tells us that, with a PE ratio of 19.7, the S&P 500 isn’t a bargain, but it isn’t exorbitant either. In other words, it’s a little high, but compared to the last 25 years, not crazily so. (That’d be the tech bubble). Besides, it’s a “misperception that the market falls due to valuation,” Elfenbeing says, when “more often stocks fall with lower fundamentals instead of prices soaring beyond fundamentals.”

Elfenbeing? Was he in The Hobbit?

Posted by on May 6th, 2015 at 7:34 pm


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