Shiller: The market hasn’t been this cheap in decades
When investing in a market like this – where every trading day seems to be just another opportunity for the market to sell off – it pays to keep a long-term perspective. That’s why historical gauges of stock market valuation like Robert J. Shiller’s cyclically adjusted price earnings (CAPE) ratio are so useful.
Designed to smooth out business cycle fluctuations and give a better picture of the market’s value, the CAPE ratio – also known as P/E10 – is similar to a standard price/earnings valuation measure. But instead of dividing the current price by the previous year’s earnings, it uses the previous ten years’ average earnings.
The following graph (from Robert Shiller’s historical data) shows that over the last 140 years or so, P/E10 has ranged from as low as 5 (in the early 1920s and then again in the early 1930s) to as high as 45 (in 2000, when Shiller’s book “Irrational Exuberance” came out). Its long-term average value is about 15, as represented by the horizontal line.
As can be seen, for the first time in decades P/E10 has dropped below 15 – it’s about 13 as of today’s close – signaling that stocks are now trading below “fair value.” Of course, as history shows, P/E10 can go still lower, so a reading below fair value isn’t an all-clear signal. Shiller himself makes this point in the following video (6:02):
He notes that while now might be a good time to get into the market, it could well overshoot to the downside and offer a better opportunity later at even lower prices – but he just doesn’t know. However, he says, if and when the P/E10 drops below 10 (which would be about 600 on the S&P 500) he’s “sure to be back in.”
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