NY Times: Making Sense of Elevated Stock Market Prices

Shares are very expensive, but so are bonds. Even at current prices, the economist Robert J. Shiller says, it is reasonable to keep some wealth in stocks.

By Robert J. Shiller, March 5, 2021

The stock market is already quite expensive. That is evident when you compare current stock valuations with those from previous eras.

But it is also true that stock prices are fairly reasonable right now.

That seemingly contradictory conclusion arises when you include other important factors: interest rates and inflation, which are both extremely low.

Examined on their own, stock valuations are at giddy levels, yet they are far more attractive when viewed side by side with bonds. That’s why it is so hard to determine whether the stock market is dangerously high or a relative bargain.

Consider that the S&P 500 index of U.S. stock prices has repeatedly set records over the past year, while a measure that I helped to create, the CAPE ratio for the S&P 500, is also at high levels.

In my view, the CAPE ratio is the more important of these two measures of overpricing because it corrects for inflation and long-term corporate earnings. John Campbell, now at Harvard University, and I defined CAPE in 1988. This is a bit technical, but please bear with me: The numerator is the stock price per share corrected for consumer price inflation, while the denominator is an average over the last 10 years of corporate reported earnings per share, also corrected for inflation.

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