Although we’ve seen enormous stock market gains over the last several years, Robert Shiller thinks investors are falling prey to “irrational exuberance” again. The Nobel Prize-winning economist is warning that the recent pullback in equities could be the start of a huge stock market crash.
Shiller co-authored an upcoming book with Janet Yellen’s husband, George Akerlof, explaining how and why stocks are overpriced. To be fair, Akerlof is not simply the spouse of Janet Yellen, but a deeply imaginative financial theorist who won the Nobel Prize for economics in 2001.
When he appears on financial news shows, Shiller is dependably calm and balanced. He’s the reasonable guy in a room full of reactionaries. For most people in finance, Robert Shiller is the arbiter of truth. He never calls his hand too early or pretends he knows more than he does.
Yet he’s turned astonishingly gloomy on stocks, going so far as suggesting a 30% decline in the coming months. Here’s why.
Robert Shiller: “Aftershocks” Are Coming
Let’s remember this is one of the smartest guys on the planet. He invented the cyclically adjusted price-earnings ratio, or CAPE, which investors use for valuations. By taking into account the market’s current position on the business cycle, CAPE provided a better picture of price-earnings than the conventional method.
As a rule of thumb, excessive optimism will drive the CAPE ratio above its historical average of 17. The ratio currently sits at 25, an ominous sign which makes Shiller uneasy.
The stock market has been temperamental of late. Periodic slumps and recoveries are roiling stock prices and then subsiding as if nothing ever happened. One of Shiller’s explanations for the volatility is that psychological factors are at play. He says they could “create aftershocks in either direction in the short-term.”
Sponsored Content: (Video) Dow Jones 7,000 Trigger Leaked by 28-year Old Stock Research Firm
“It could be followed by even bigger and bigger moves,” he said in an interview on CNBC. “I have a general bias towards down because the market is overpriced.” (Source: CNBC, August 21, 2015.)
Is he right? Is it time to sell? Those questions differ from portfolio to portfolio, but by and large the answer is yes. We’ve seen stock prices seesaw downwards in the last month, erasing all their first-quarter gains. The tipping point is coming.
Waves of pessimism were lapping at the feet of markets, but there’s tidal wave on the horizon.
Shiller Warns of 30% Declines
Robert Shiller, the calm purveyor of stock markets, thinks we’re in for massive declines. If you’re not a financial news junkie like myself, this may sound unremarkable. But it’s indeed huge.
Economists are used to big-picture thinking, making them fundamentally uncomfortable with hard-edged predictions. Shiller exemplifies that personality type. But even he couldn’t hold back with CAPE running so high.
“It is entirely plausible that the shaking of investor complacency in recent days will, despite intermittent rebounds, take the market down,” said Shiller. “This would put the S&P closer to 1,300 from around 1,900…and the Dow at 11,000 from around 16,000.” (Source: The New York Times, August 30, 2015.)
There you have it, folks. Even the most level-headed assessment of our current stock market says it’s wildly overvalued. Get out while you still can.