Consuelo Mack WealthTrack

CAPE fear: Little-known ratio offers big warning

Apr 9, 2013 @ 12:00 am

Runtime: 3:59

Yale University's Robert Shiller says that the cyclically adjusted price-to-earnings ratio for equities is high ó and could signal a retreat in stocks.

Video Transcript

This week on WealthTrack. What does visionary Yale economist, Robert Shiller, who predicted the bursting of the tech and housing bubbles, think about stock and home prices now? And what does the author of the rationale exuberance thing, bonds are dangerous. Answers from Robert Shiller are next on Consuelo Mack WealthTrack. -I began the interview by asking Shiller to assess the stock market's current value. -A lot of people emphasize that it set new records lately. But if you correct for inflation, it isn't even close to a new record. So, there's so many different ways to describe the market. What I'd like to do is look at the price growth and do some measure of fundamental value. And I have my own method of doing that. I worked it out with Professor Campbell at Harvard years ago. It's price divided by 10 year average earnings. -Right. -Which I think is-- for various reasons, it's a more sensible definition of value. -And why is that? -Well, you want to look at it relative to fundamental value, I mean, if earnings have gone up a lot, then you naturally would think that the stock market should go up too. But of course, if earnings go up very quickly, then maybe you don't believe that. You want to take a longer average of earnings. And Campbell and I found that when the price does get high relative to ten year average earnings, the market tends to go down afterwards. -So is it high now relative to ten year average earnings? -It's somewhat high. But it's not super high. So the CAPE Ratio-- -Right. -and that stands for Cyclically Adjusted Price Earnings Ratio, which I've just described, is at 23 now for the standard in 4500, which puts it high -'Cause the average is-- -but-- -15? -about 15, yeah-- -Right. -for the last century. That's high, but it's not super high. In March of 2000, it got up to 46. It's twice as high as it is now. And then, of course, we know what happened after that, the stock market ever since, has not produced any money in the 13 years since then. Right now, even on a total return basis, inflation corrected, it's down below the peak of 2000. So it's a bad sign when it gets really high. Well it is somewhat high now, and so that's a bit of a bad sign, but it's not a horrible sign. -Housing market. You predicted the housing bubble. There is-- has been some recovery in the housing market, you know, the housing permits, housing starts-- -Right. -sit prices are up, there's a shortage of inventory in some markets. So, what's your take on the housing market right now? -Well, this is a very interesting question, where is it going? In some cities, it looks like, we're back to the races. Phoenix is the best example, and from California, Los Angeles, San Francisco and Las Vegas, you know, there are booming areas. The bigger question though is, how long will it last? You know, bubbles do come to an end. And secondly, how pervasive is it? You know, if you're living in Detroit or St. Louis, do you think, is this relevant to me? So, I'm careful about making any general remark. I think that the general perception you get from reading newspaper, watching TV is a little bit too optimistic. I don't think that we're off to the races again in most places. And I think that there is still a risk of declines.

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