Robert Shiller turns sour on “way overpriced” stock market.
The stock market is still flying high. OK, so the Russell 2000, the index of small-cap stocks, dipped into the negative for the year. The Nasdaq is still up 7.5%, the S&P 500 and the DOW about 5%. They’ve been edging down recently. But they’re still hovering near record highs. So why worry? Stocks can only go up. That’s what we’ve learned since 2009.
Robert Shiller, the Nobel Prize winner who correctly turned sour on the stock-market bubble of the late 1990s and the housing bubble a few years later, has turned sour on stocks again. He isn’t a perma-bear. On the contrary. But he is an interesting voice that folks ignored the last two times to their detriment.
“The market is way overpriced,” he told Bloomberg. “It’s not as intellectual as people would think, or as economists would have you believe.”
But that doesn’t mean the market has to go down right this minute. Irrationally priced financial markets, by definition, don’t have a rational limit anymore. Housing markets do have a rational limit: affordability. Affordability can be expanded with lower interest rates, higher leverage, and more government involvement. But in the end, enough people have to be able to live there, or else the market seizes. But no one has to live in irrationally priced stocks. So they can continue to surge way beyond any rational limit. Until they too flip.
So when is it time to bail out? Shiller, even as he sees the market as overpriced, sees a 4% upside. “I can’t speak authoritatively,” he cautions. “This is guessing human psychology.”
That’s his point. Financial markets are about human psychology. And now there’s a new element in the equation, as he calls it on Bloomberg TV: the “Trump effect.”
“My guess is that the Trump effect is really important,” he says. “Trump dominates our attention.” And the Trump effect is all over the world. “I think it should be stimulative in a psychological sense, beyond whatever is going on with tax rates.”
But he is worried. His own CAPE Ratio – “Cyclically Adjusted PE” Ratio, a price-earnings ratio that is based on average inflation-adjusted earnings from the previous 10 years (chart) – is at 29. The median historical CAPE Ratio is 16.
This is “very high, not quite as high as it was in 1929, but it’s getting close, so that’s a bad sign,” he says. “But on the other hand, the stock market has historically done so well, so many times, it seems to me this could be like 1997 again when the CAPE Ratio was also around 29. And you know if you held on for 10 years, which brings you to around 2007, you did just fine.”
But not if you held on another year or two. If you missed the exit point, you’d have to hold on to it for some more years. In the Nasdaq’s case, you’d have to hold on to it till July 2016, before it hit 5,000 again, after having hit it briefly in early 2000 before crashing, and re-crashing in 2008.
“That’s the uncertainty of the stock market,” Shiller says. “It has historically often done well when it shouldn’t have.”
“Given that, with just the CAPE ratio, it doesn’t look promising,” he says. But he cautions: usually we can’t forecast the stock market in the short run. We can forecast it better in the long run, over 10 years.
Markets have been fueled by promises of stimulus and tax cuts and the “Trump effect.” But what will happen if the hopes for fiscal stimulus and other things don’t come to pass? Not a rosy scenario, according to Shiller:
“Well, it will be a declining stock market,” he says. “It’s not just the fiscal stimulus. It’s the whole package of Trump. We’ve seen how much anxiety there has been generated in the first month of his presidency. It’s really an uncertain time.”
And yet… “The stock market could do very well,” he says, “it could go up 10%, 20%, 30%… if Trump does things well, if things work out.” Alas… “I’m talking about over 10 years.”
That’s a lot of IFs, over a 10-year time frame, which would boil down to annual gains in the best-case scenario of just above the current rate of inflation, and only “if Trump does things well, if things work out.”
So when is the time to get out of the market?
“This is called market timing,” he says. “And in the short run, it’s very difficult to see when to bail out.”
“If there is anything like a sign to bail out it would be the high CAPE Ratio,” he says. “To me that just gives me caution, don’t go overboard,” he says. And he added: “Don’t assume that Trump is going to work miracles.”
Because miracles might be required to sustain this market.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
I just might see the big short movie since John Paulson is a AIG board member.
have stopped putting an X on my day planner ( I find myself staring endlessly at the wall calendar while steely Dan ” the last mall” nailed it a dozen years ago!
“If you missed the exit point..” “Hold on 10 years…”
So how do the Pension plan and 401k enrollees get to exit? Hold on 10 more years and hope they are still alive at 75?
No soup for you!
Or exit their equity holdings within their portfolios and shift to bonds or some other option. This of course would apply to those with self-directed 401k’s.
The bond fund or if it has a money market fund get in it.
There is a tremendous draw on none government money market accounts since liquidity is so last year that it should have a risk free yield.
Silver dimes- 20%.
if..if….if…if..a lot said about nothing….It could go up. It could go down. It could stay the same…
John Hussman gives you more meat and potatoes and he never won a Nobel Prize. His comments on Buffet’s opinion last week were good. I bet the sage from Omaha doesn’t want to be the one to start a mad dash to the exists so he said stocks were still good despite his favorite indicators for value show no value at this time.
If there is Trump effect it will not because of earnings, it will because people are trying to hedge the monetary inflation Trump deficits would cause. At least by being in stocks the future cash flows might get adjusted for the amount of monetary inflation where existing cash or bonds will get hammered.
“John Hussman gives you more meat and potatoes and he never won a Nobel Prize. ”
Is Mr. Hussman an Investment Manager ? He’s probably an Ivy league MBA or Phd. They normally are. What’s Hussman’s 10 &15 yr track record like ? That usually determines the proof of the pudding.
Moreover, overvalued or undervalued should not matter over 10 years or so. There is usually a bull market somewhere every once in a while. Long, short, gold, whatever.
BTW, i agree with those that say that both paper and real assets are very overvalued.
Right now seems to me like mid 2007, as far as broad valuations go.
Dangerous !
“BTW, i agree with those that say that both paper and real assets are very overvalued.”
“Right now seems to me like mid 2007, as far as broad valuations go.”
“Dangerous !”
Couldn’t agree more!
Hussman is an investment manager. Smart guy.
His track record has been pretty poor lately, namely because he underestimated the post-GFC recovery.
BUT he was right in 2000 and 2007 prior to both crashes, and his argument is the same today: it’s all about valuation and long-run returns, and today’s valuations are dangerously high.
IMO, watch high yield credit, oil, the yield curve, the dollar… those are going to be your market signals that something is changing. Of course, there’s event risk as well which is much harder to predict. Eurozone political problems, intra-Middle Eastern strife (Saudi Arabia and Iran squaring off), Russia v Eastern Europe, North Korea, South China Sea… lots of things, plus the totally unpredictable ones as well (e.g. 9/11).
regarding: and only “if Trump does things well, if things work out.”
’nuff said. Good time to bail, imho. That is if the news means anything. Of course I have been out of stocks for a long time and missed this last big run up. Does anyone really know anything about this market? Nobody seems to make money on actual company performance or sales, it’s all simply speculative financialization. That is way beyond anything I understand and I don’t mind admiting it.
Whatever happened to having a good idea, finding a market or niche, producing and selling, and floating an offering on historical performance for expansion financing? I thought that is what the stock market was all about? Silly me.
Hand in hand with the current PE ratio is the ‘price to book value’ which currently sits at the “heady” level last seen in 2004!
The 10 year Treasury is knocking on the three percent door at 2.595 % once that level is breached and holds, sits a boatload of sell orders. If the rate climbs past 3.50 % the panicked exodus to the exit door will become a flood.
The Russell 2000 is breaking down after almost reaching 1,400 on February 17, 2017 now sitting at 1,361.49 after a loss of eight points today.
The ratio of insider sales to buys sits at 45:1 the current insider selling trend started in mid-December 2016, this is the “smart money” vacating the market. Yet the “dumb money” continues to pour in, as can be seen in the Daily Sentiment Survey of Traders sitting at 92% bulls!
There has been absolutely ZERO times in history that the Federal Reserve has begun an interest rate hiking campaign, that has not eventually led to a negative outcome. The proof will be in the pudding tomorrow, as the market has NOT fully priced in the coming rate hike.
Can you imagine if she surprises everyone and doubles up with a 50 basis point raise? Things are getting interesting.
The Taylor Rule would have the Fed Funds rate at about 3% higher than what it is today. Can you imagine the consequences of that?
A half point raise would be a good start, but she’s got a long way to go to get back to normalcy.
Absolutely. That’s kind of my point. I think even a half point would shock people.
I was thinking the same thing
When the economic experts finally admit there is no economic basis for the valuations, what more do you need. Run, unless you really enjoy the gambling. There’s a reason they used to call trading the markets speculation.
The stock market will tumble when the last bear capitulates and that last bear is not Shiller, it’s David Stockman.
The stock market may tumble but the hot place would need to freeze over before David Stockman capitulates. There are a few other fanatical permabears like him out there who told the media that it was far too early to jump back into equities in March 2009.
In fact, Shiller can be a little bearish in his own right. Here’s an excerpt of his from 2008.
“Robert Shiller, professor from my alma-mater, Yale, opines the following, “In terms of the stock market, the price/earnings ratio is no longer high…But after the stock market crash of 1929, the price/earnings ratio got down to about six, which is less than half of where it is now. So that’s the worry. Some people who are so inclined might go more into the market here because there’s a real chance it will go up a lot. But that’s very risky. It could easily fall by half again.”
The link is below if you are bored.
https://www.erictyson.com/articles/20081217#.WMhTyeIrKM8
Nah I don’t want to sound cruel, but given Stockman’s age, he may “capitulate” yet. Also I’ve always suspected that he is a bull, otherwise how is he funding his retirement?
All these saber rattling about how this and that is similar to 1929 is missing the point. In 1929, the Fed and other CBs were not actively manipulating the US stock market. They are doing that now. Also the Fed still has MANY weapons left i.e. they can buy ETFs ala the Japanese Central Bank and of course they still haven’t done NIRP. There’s enough wealth to plunder in other words.
The FED is trying desperately to avoid NIRP because it’s a roach motel. It’s not unlikely that other central banks (Swiss?) are buying the etfs to give more juice to the usual shenanigans of the plunge protection team (S&P futures).
The manipulations can go on a looooong time, but they can’t go on foreva. Witness two stock market crashes and a national real estate crash in a mere decade.
What we don’t know is what fetid cesspool of “securities” are bubbling in the dank corners of bank spreadsheets waiting to be uncovered by higher interest rates.
Every time the Fed raises rates by 25 basis points is like pulling the trigger one more time and hoping for an empty chamber. One of those times will see gray matter and bone exploding from the DJIA.
Interesting. Didn’t know it had gray matter. ;-)
When you can see it’s time to get out, you are too late.
So what’s the takeaway ? If stocks ever get down to a p/e of 12 again (or even a 50% drop), you can bet there will be a chorus of experts who will scream “stay away”.
Best…PJS
https://app.hedgeye.com/insights/57783-global-growth-as-strong-as-it-s-been-in-2-years
maybe i’m wrong but there doesn’t seem to be a correlation between stock market valuations and gdp growth . Here in the US the we have had tepid gdp growth post recession 2.0. However look at stock market valuations. Also at the risk of sounding patronizing, Wolf did an exemplary job of financial journalism in his interview with Max Kieser.
Global growth as strong as its been in 2 years… hahahaha.
Meanwhile, Atlanta Fed just downgraded Q1 GDP AGAIN, this time to 0.9% (annualized!). Reminder: they were projecting almost 3.5% back in February. This would make it the third worst quarter since exiting the recession in Q2 2009 (Q1 2011 and Q1 2014 were worse).
Assuming the Fed raises rates later today, it would be the weakest quarter in THIRTY YEARS that they’ve raised rates. Thirty years = 1987… something happened to the stock market back then, I think.
Smingles, ah yes… Black Monday.
Reasons for the 1987 decline included program trading, overvaluation, illiquidity and market psychology. Sound familiar?
I was a RE Broker (Texas) at that time and it was ugly. The only upside was that a lot of the S&L rat bastards went to jail.
Great 80s story of Fast Money and Fraud Texas style: http://www.nytimes.com/1989/04/23/magazine/fast-money-and-fraud.html?pagewanted=all
Just in case you wern’t being sarcastic.
To many traders out there today are to young to remember it or that it started in ASIA.
In finance, Black Monday refers to Monday, October 19, 1987, when stock markets around the world crashed, shedding a huge value in a very short time. The crash began in Hong Kong and spread west to Europe, hitting the United States after other markets had already declined by a significant margin.
https://en.wikipedia.org/wiki/Black_Monday_(1987)
Tomorrow is a big day. Debt ceiling that no one is paying attention to.
Doesn’t matter anymore. Republicans control the gov now.
Fiscal Conservatives and the Freedom Caucaus may balk at a debt ceiling increase. But…. are there any Fiscal Conservatives left these days ?
Witholding a debt ceiling revision is a political tactic for these people, not a principle. Now that they control the government, I’m betting it’ll sail through without a peep.
“That’s his point. Financial markets are about human psychology.”
He’s right on the money :)
Money is a promise of more nonexistent tokens in the future, the trust in the narrative. That is all there is to it. There’s no grand banking conspiracy, people (at ALL levels) simply think the future will be brighter, so they promise to give back tokens that are logically impossible to give back, because they cannot issue them or obtain them (mining gold) because they would be worthless if they existed in quantities enough to satisfy the I.O.U.s, but they do it nonetheless. Then they will insist theyr promises are holier than others, because theirs are for investing, or producing, or whatever. Tokenising promises was probably the greatest achievement of the human race, and, of course it’s demise, because in evolutionary terms, the price for being at the very top of the food chain is not a gold medal and a room on Starship Enterprise, but a hard reality clash:
https://www.youtube.com/watch?v=OBE1_EHgpb0
Lights out.
The forward guidance after this hike (or not) will be a train wreck.
I would be grabbing the umbrella handle as far down toward the curved handle as possible
The fed has left the building out the back dock!
A lot of this stock price insanity has been driven by corporate buyback’s.
Would a tail off in those, be an indicator???
Dear Wolf,
It happens that Shiller is making a point here against bubbles, against hype and spin, and for sanity.
I have a problem with the presentation of his credentials even though I happen to like what he happens to be arguing here. Mirowski raises objections to Shiller and to behavioral innovations on orthodox economics. He writes in _Never Let_, “Shiller’s previous books did indeed identify the housing bubble as a potential problem, but his ‘solutions’ always involved even more baroque securitizations of the assets in question, as well as getting more people invested in Wall Street even deeper than ever. He finally revealed his true colors soon thereafter in his unabashed apologetics for financial-sector jiggery-pokery in his Finance and the Good Society. In this, he rivaled the most avid Reaganite in his belief in the superior power of the market to fix any problem.” So I would like to gently question the wisdom of granting Shiller this role where he is taken to be wise or prescient, even though I happen to favor what he happens to be saying here. He sometimes sounds the alarm bells for things early and that’s good, but as he is promoting more baroque financial engineering, he is also contributing to one of the causes of crises.
Perhaps “Nobel Prize winner” should not be used in an abbreviated kind of way in stories, for an economist who won the Swedish Bankers’ Prize?
https://fivethirtyeight.com/features/the-economics-nobel-isnt-really-a-nobel/
thanks
Kevin