As markets pull back this morning, all eyes are on the European Union bailout of the tiny island-nation of Cyprus, funded in part by a one-time tax on the nation's bank depositors (ouch!).
As we wait for a delayed parliament vote on the bailout terms in the eurozone nation, those looking for another reason to take some profits now or keep money on the sidelines can find reinforcement in another indicator.
Robert Shiller, professor of economics and finance at Yale University and co-creator of the S&P/Case-Shiller Home Price Index, keeps a record of stock valuations. Right now, his index is showing stocks are overvalued and the market could be headed down.
Shiller’s “cyclically adjusted price-earnings ratio,” or CAPE, is approaching a level not seen since the last stock market bubble in October 2007, just before it burst. The CAPE stands at 23 compared to a historical average of 15. At the same time, it reached a high of 46 at the height of the big boom of the 1990s.
“The CAPE ratio has predicted long-term returns,” Shiller tells The Daily Ticker. The other side of it, though, is “when CAPE gets high, the market does tend to go down. It’s a simple value proposition – what goes up must come down.”
“I don’t have an alarmist view about this,” he adds. “The market is high but it’s not horrible.”
For perspective, he describes a different feeling leading up to the tech bubble bursting.
“I think it was a strong ‘new era’ feeling,” Shiller says of the dot-com fervor driving the bubble. “People got overexcited about something they thought was life-changing. We’re not in that circumstance now. We’re bruised and battered and hoping to come out of this all right, so it’s a different environment, which seems less likely to me to lead to a real bull market. But you never can be sure.”
In terms of the bubble mentality of excitement and people pouring into the market because they are afraid of missing out, Shiller says, “Some of that is happening now but the question is how enduring it will be.”
So in terms of whether we have a bubble, no bubble or the forming of a bubble, he says it's “quite a risky environment right now” and it could be any one of those. “It has been a bit bubbly, but I kind of give them all equal probability,” he says, warning of “big movements one way or the other.”