The stock market is rallying to new highs, and its party time down in the midst of wall st. While the S&P 500 is reaching all-time highs on the excitement and optimism about Donald Trump getting in, some wall st analysts and strategists are getting increasingly worried about a widely followed indicator that has now reached levels that preceded most of the major stock market crash over the last 100 years.
The cyclically mathematically adjusted PE ratio, a valuation used for many years, by a top world class economist Robert Shiller, now stands at over 27, and has been exceeded only in the 1929 hyped up mania, the 2000 dot com boom, and the 2007 housing bubble and stock bubble. It’s probably not time to get on your knees and pray to God, and panic. But there is reason to have specific caution here at the end of 2016.
Let’s say the markets earnings will increase by 10-12 percent under the Trump administration as he starts to implement his policies. We are still dealing with the same overall picture here, in that the stock market is very overvalued on a fundamental approach. In the grand scheme of things, we have not seen things so overvalued and at extremes in over 40 odd years. That is not only worrisome, it’s setting people into a false sense of security like it did back in 2007, right before the subprime fiasco.
Yale economics professor Robert Shiller’s has won awards for his research that found future 10 year stock market returns are based on a negative correlated CAPE ratio. This set him apart, and gave exact valuations on stocks, bonds and the stock market in general, where as in the past other analysts were just guessing.
If we look at the market from a common price-earnings ratio, which is much different than Shillers theory, the market still looks very overbought here. That P/E Ratio is based on the earnings from the last 12 months, and currently that stands at 19. If you look back, a reading of 19 is the highest it has been for more than 12 years. That is quite incredible, and reason for concern no doubt.
Of course the other side to the coin here, and even as astute has Shiller is. He also admits, when readings get to a certain point, or extreme, that does not necessarily mean the stock market will crash. All it means, is that the stock market has gone into an area, over time that is seen as being in a bubble territory, and bubbles have a tendency to start to deflate and eventually burst somewhere down the track.
Shiller did warn his subscribers that there is no need to panic. Because in the past extreme readings took months, or years to correct themselves. And usually there is a fundamental catalyst to set things off. Right now it seems investors are looking to new starts, and a new economy with Donald Trump in office. He keeps using the phrase “Let’s Make America Great Again” but what is he going to do to make it so great, if the US is in huge deficit, debt levels are at historical levels and just as you read the stock market is at historically overbought levels not seen in over 40 years. Hopefully Mr. Trump has a good plan, because the alternative might not be a pretty sight to see.