Shiller: Stocks fairly valued but could “go down a lot”

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With the S&P 500 Index after yesterday’s surge again slightly above the “neckline” (of the head-and-shoulders formation referred in a post last week), I will be monitoring things very closely over the next day or two to see if the impressive bounce was just a one-day wonder or something more enduring.

Meanwhile, the S&P 500 is now fairly valued on a long-term cyclically adjusted P/E (CAPE) basis, according to Robert Shiller (as reported by Yahoo Finance, Tech Ticker). Shiller is economics professor at Yale and author of, among others, Animal Spirits, Subprime Solution and Irrational Exuberance.

In order not to work with notoriously unreliable forward-looking earnings estimates, I have always preferred using Shiller’s CAPE methodology, or normalised earnings, as they average ten years of earnings. This measure provides a good picture of the market’s value regardless of where we are in the business cycle. I have therefore been updating a CAPE chart for a number of years. On this basis, the multiple increased to 15.8 during the March-May rally, representing “neutral” value when compared to a long-term average of 16.3.

shillerpic1

According to Yahoo Finance, Tech Ticker, Shiller is skeptical of the “green shoots” viewpoint and is of the opinion that it would take a considerable period of time for the economy to return to normal growth. Although the stock market’s neutral valuation implies a long-term average return of 7%, he is not forecasting that outcome due to the “precarious state” of the economy that could stumble anew and cause stocks to “go down a lot”.

As mentioned in my “Words from the Wise” post on Sunday, the stock market technicals undoubtedly look ugly and investors will now focus on the second-quarter earnings reports as a test of whether stock prices have run away from fundamental reality. While investors wait for Mr Market to show his hand, a cautious approach is warranted, but that should not preclude one from finding stocks that look cheap.

Click on the image below to view Aaron Task’s interview with the famed professor.

Source: Yahoo Finance, Tech Ticker, July 10, 2009.

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2 comments to Shiller: Stocks fairly valued but could “go down a lot”

  • Thomas Bach

    Robert Shiller once said that he is a bad with timing the markets.

    BAC/Merrill thinks the recession is over!

    A report “Recession is Over!” was published this late afternoon by Michael Hartnett, head of Merrill’s research investment committee, it said recovery will take time and require sustained government support, but that “our global economists believe the recession ended in Q2 2009 and a fragile recovery has begun.”

    Merrill recommends to their clients to start accumulating stocks.

    The news should widely propagate via the media by tomorrow morning (before the market open).

  • Thomas Bach

    From the report:

    Growth forecasts up
    That’s the key message from the July RIC Report. The global recovery is likely to
    be slow and require sustained policy help. But an inflection point in the global
    economy should encourage investors to rebalance their portfolios to reduce cash,
    and look for opportunities to increase equity exposure while staying with high
    quality bonds.

    Give recovery a chance
    Encouragingly, our global economists believe the global recession ended in
    Q2’2009 and a fragile recovery has begun in the third quarter. We are revising
    growth forecasts up virtually across the globe, but most notably in the US and
    China. The 2010 global GDP forecast is now 3.7%, with GDP growth in the
    emerging markets at 5.5% forecast to outperform growth in developed markets at
    2.2%.

    Cash should be reduced
    The RIC believes that cash positions have remained exceptionally high through
    the first half of 2009 and asset allocation has suffered as a result. For example,
    the recent Merrill Lynch/Cap Gemini 2008 survey of high net worth individuals
    showed that cash represented a whopping 21% of assets.

    We are bullish on global equities
    Equities have already staged a strong recovery from their bear market lows. And
    in developed markets we expect to see big, fat trading ranges prevail over the
    medium term.

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