Making sense of sky-high stock prices

This is a really interesting yet conflicting blog by Robert Shiller.

There has been much puzzlement that the world’s stock markets haven’t collapsed in the face of the COVID-19 pandemic, and especially in the United States, which has recently been setting record highs for new cases. But maybe it isn’t such a puzzle. A measure we call the Excess CAPE Yield (ECY) puts the long-term outlook for the world’s stock markets in better perspective.

the level of interest rates is an increasingly important element to consider when valuing equities. To capture these effects and compare investments in stocks versus bonds, we developed the ECY, which considers both equity valuation and interest-rate levels.

The ECY in the US, for example, is 4%, derived from a CAPE yield of 3% and then subtracting a ten-year real interest rate of -1.0%

The ECY for the UK is almost 10%, and around 6% for Europe and Japan. Our data for China do not go back as far, though China’s ECY is somewhat elevated, at about 5%. This indicates that, worldwide, equities are highly attractive relative to bonds right now

The only other time ECYs were this high using our global data was in the early 1980s. That period was characterized by depressed equities with cheap valuations, high interest rates, and high inflation. CAPE ratios for the five regions were in the low teens back then, compared with levels in the twenties and thirties now. These conditions are almost the opposite of what we see today: expensive equities and exceptionally low real interest rates.

Eventually, down the line, bond yields may just rise, and equity valuations may also have to reset alongside yields. But, at this point, despite the risks and the high CAPE ratios, stock-market valuations may not be as absurd as some people think.

This is an unusual stance for Shiller.

He published a book that called the dot com market a bubble, right before it crashed. He revised the book to highlight that housing was in a bubble, a few years before that crashed. He revised it yet again a few years back to call bonds (and everything else) overvalued.

Buffett also had a similar take, although he sounded more pessimistic about negative rates lasting.

https://www.cnbc.com/2019/05/06/warren-buffett-says-stocks-are-ridiculously-cheap-if-interest-rates-stay-at-these-levels.html

“I think stocks are ridiculously cheap if you believe ... that 3% on the 30-year bonds makes sense,

“We are sitting very, very little inflation with the Federal Reserve putting a target at 2% not that long ago. ... Since money doesn’t cost anything, you can print lots of money and have full employment and no inflation. … I wouldn’t think you can have these things at these levels — long-term rates, interest rates, budget deficits — have that at a stable situation for a long period of time,” Buffett added.