Investors who see the United States market as dangerously overvalued invariably cite the work of Nobel economist Robert Shiller, but it seems the Yale professor isn't quite as pessimistic as he is often thought to be.
Shiller has popularised the cyclically-adjusted price-earnings ratio, or Cape, which averages earnings over a 10-year period in an effort to estimate if stocks are overvalued or undervalued. Right now, US stocks’ Cape ratio is 33 – higher than the infamous 1929 stock market peak and a level only ever exceeded during the dot-com bubble.
Justified
However, critics have long complained that a higher Cape ratio is justified in a world of zero-interest rates – a viewpoint that Shiller has come to share.
Shiller has developed a new measure, the excess Cape yield (ECY), which considers both equity valuations and interest rates. It indicates global equities are cheap and “highly attractive” relative to bonds, particularly in the UK, Europe and Japan.
As for the US, the ECY suggests inflation-adjusted returns of about 5 per cent over the next decade.
Of course, if bonds yields eventually rise, then stock valuations may also have to “reset”, says Shiller. “But, at this point, despite the risks and the high Cape ratios, stock market valuations may not be as absurd as some people think.”
