Investor sentiment today is looking like it did in 2000 and we could be due for a stock market crash of 30% or more. At least, that’s the opinion of famed economics professor Robert Shiller.
In an interview with CNBC’s Squawk Box on Tuesday, the Yale University professor and Nobel economics laureate says many investors believe the stock market is overvalued, but they’re confident that asset prices will continue to rise in the short term. It’s the type of bubble mentality speculators embraced in the late 1990s, just before the dot-com bubble burst. (Source: Robert Shiller: THIS is the sign we’re in a bubble, CNBC, September 15, 2015.)
“That’s the sign of the bubble. They’re worried but they’re thinking they’ll get out,” he explained. “This can suddenly turn, and we’re looking somewhat like that now.”
To back up his case, Shiller highlighted his Cyclically Adjusted Price to Earnings (CAPE), comparing stock prices to earnings over the course of 10 years. Today, the CAPE ratio currently stands at 25, Shiller explained. That’s far above the market’s historical average of 17.
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Other factors are keeping Shiller on edge. The exceptional growth in earnings, a key factor behind the market’s recent rally, is unlikely to continue in the coming year. And as investors focus on the recent extremes in stock volatility, there’s a real risk of a stampede out of the market.
“It wouldn’t surprise me at all,” he explained. “And then there would be a reaction that people have been thinking about this, and now they’ll react more quickly.”
How far could the stock market crash in 2016? In Shiller’s view, a new bear market wouldn’t be surprising. U.S. equity markets need to decline by 30% or more to bring valuations back to their historical norms.
“It is entirely plausible that the shaking of investor complacency in recent days will, despite intermittent rebounds, take the market down significantly,” wrote Shiller last month. “This would put the S&P closer to 1,300 from around 1,900 on Wednesday, and the Dow at 11,000 from around 16,000.” (Source: Rising Anxiety That Stocks Are Overpriced, New York Times, August 27, 2015.)