Shiller: Stocks fairly valued but could “go down a lot”
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July 14th, 2009 by Prieur du Plessis, Investment Postcards from Cape Town
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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.
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.
Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.
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