Shiller Not Very Positive About Asset Prices

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Includes: DIA, IYR, SPY
by: Michael Panzner

I'm not an economist or a Wall Street strategist. Moreover, I'm not a senior financial industry executive or a central banker. So, based on the criteria the mainstream media uses to qualify its "experts," I guess my opinion doesn't matter very much.

However, there is one fellow who is widely viewed as an expert and who has proven that he actually understands economic reality. His name is Professor Robert Shiller, and neither of the following two articles citing his work and perspectives paints an especially positive picture for asset prices in the period ahead:

"So, How Are Stock Prices Now That We're Back At DOW 11,000? They're 30% Overvalued" (Business Insider's The Money Game)

So, how do look now that the DOW is back to 11,000?

Not outrageous. But certainly not cheap.

Measured using our favorite valuation technique, Professor Shiller's cyclically adjusted PE analysis, the S&P 500 has a PE of 22X. The long-term average (1880-2010) is about 16X. The current level is actually close to the big peaks of the past--with the exception of the gigantic one that peaked in 2000.

Check out the chart below, from Professor Shiller's web site. The blue line is the cyclically adjusted PE ratio for the last 130 years. (The cyclically adjusted PE mutes the impact of the business cycle by averaging 10 years worth of earnings. This reduces the misleadingly low PEs you get at peak profit margins, like the ones in 2007, and the misleadingly high ones at trough profit margins, such as the ones we had last year).

Note a few things:

The long-term average for the cyclically adjusted PE is about 16X.

Stocks have spent vast periods above the average and vast periods below it, usually in multi-decade cycles.

We've just descended from the longest period of extreme overvaluation in history, suggesting (to us, anyway) that the next multi-decade cycle is likely to be below average.

At today's level, 1200 on the S&P, stocks are trading at a 22X CAPE, about 30% above the long-term average.

Shiller PE April 10, 2010

"Shiller: 'Don’t Bet the Farm on the Housing Recovery'" (Calculated Risk)

From Robert Shiller in the NY Times: Don’t Bet the Farm on the Housing Recovery:

MUCH hope has been pinned on the recovery in home prices that began about a year ago. A long-lasting housing recovery might provide a balm to households, mortgage lenders and the entire United States economy. But will the recovery be sustained?

Alas, the evidence is equivocal at best.

The most obvious reason for hope is that, unlike stock prices, home prices tend to show a great deal of momentum.

Momentum only goes so far. And I think it is likely that prices will fall further in many bubble areas later this year as more distressed properties hit the market.

Shiller also argues prices might fall:

Consider some leading indicators. The National Association of Home Builders index of traffic of prospective home buyers measures the number of people who are just starting to think about buying. In the past, it has predicted market turning points: the index peaked in June 2005, 10 months before the 2006 peak in home prices, and bottomed in November 2008, six months before the 2009 bottom in prices.

The index’s current signals are negative. After peaking again in September 2009, it has been falling steadily, suggesting that home prices may have reached another downward turning point.