Robert Shiller's famous cyclically-adjusted price-earnings (CAPE) ratio is telling us that the stock market looks a bit expensive these days.
CAPE is calculated by taking the S&P 500 and dividing it by the average of ten years worth of earnings. If the ratio is above the long-term average of around 17x, the stock market is considered expensive.
Currently, CAPE is at around 25.2, which means we could be in for a long period of low returns in the stock market.
Some folks think that this means we're about to see a big sell-off or perhaps even a crash.
"The trouble is that the last two times the CAPE crossed 25 (in 1996 and 2003) the bull market was just getting started and ran for another four years," notes Deutsche Bank's Stuart Kirk.
In Kirk's first example, the S&P 500 went from 614 in December 1995 to 1,485 in August 2000 for a 141% rally. In the second example, the S&P 500 went from 1,038 in September 2003 to 1,520 in 2007 for a 46% gain.
Obviously, two isn't a large enough sample that you can have any confidence in the historical pattern. But the bottom line is that corrective mean reversions in these ratios rarely happen suddenly or quickly.
"Market multiples rarely trade at average levels," said Morgan Stanley's Adam Parker.
Yale, Business Insider
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