Long-term economic growth remains slow, despite a rebound in both equities and housing. This is a clear sign that the market is overheated, warns Robert Shiller, Nobel Prize-winning economist and co-author of the book Phishing for Phools.
"The correction in August brought the market down ten percent," Shiller says. "But it's halfway back up. It's still looking pretty frothy.”
Shiller adds that his valuation confidence index, known as the CAPE ratio, is far above the historical norm of 17. The ratio, which compares current stock prices to earnings over a ten-year period, currently measures 24.5, near the peak it reached before the financial crisis in 2007.
“On top of that, I have survey data showing that [a high percentage of] people think the market is overpriced,” he says. “This this creates a little bit of fear that there could be a correction. When we saw the correction in August of this year, there was some anxiety thrown into people's hearts.”
While Shiller expects a further drop in the market, he warns against making any extreme moves. He says that investors should not pull out of stocks completely, but also that they should "not be heavily exposed to the market, because it's worrisome at this point. Worrisome but not horrible." For this reason, Shiller says he has reduced his own exposure to equities.
He also notes that recent gains in the housing market may not be sustainable. “I'm starting to worry a little bit, it's getting high by historical standards,” he says, adding that housing is a cause for concern, but it's not quite like the stock market yet in terms of valuations.
“Usually housing has not been a great investment, owner-occupied housing,” he says. “Unless it gives you pleasure... I think people tend to overestimate the investment value of housing, especially at a time like this, when home prices are already high.”