Shiller: ECY & Justification For Sky-High Stock Prices

In a recent interview, Dr. Robert Shiller justified “sky-high” stock prices by using a measure called the “Earnings CAPE yield” or ECY. To wit:

“There has been much puzzlement that the world’s stock markets haven’t collapsed in the face of the COVID-19 pandemic. 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.” – Shiller

Before we dig further into his analysis, it is essential to review what we have previously stated about valuations. As discussed earlier in “Shiller’s CAPE – Is It Just B.S.”

The problem is that valuation models are not, and were never meant to be, ‘market timing indicators.’  The vast majority of analysts assume that if a measure of valuation (P/E, P/S, P/B, etc.) reaches some specific level it means that:

  1. The market is about to crash, and;
  2. Investors should be in 100% cash.

Such is incorrect. Valuation measures are simply just that – a measure of current valuation. More, importantly, when valuations are excessive, it is a better measure of ‘investor psychology’ and a manifestation of the ‘greater fool theory.’”

What valuations do provide is a reasonable estimate of long-term investment returns. It is logical that if you overpay for a stream of future cash flows today, your future return will be lower.

“Price is what you pay. Value is what you get.” – Warren Buffett


Markets Are Expensive

Doug Kass recently made a salient point:

“By taking rates to zero and providing excess liquidity has made the price-earnings multiplier, determined  by a near-zero risk-free rate of return, an unknown quantity. Like a projectile capable of taking those valuations to unrecognizable levels, at least based on history.

This despite a mountain of global debt and numerous other secular and structural headwinds. The table of 15 stock market valuation factors show 11 at record levels. The other four are at all-time highs.”

Justification Sky-High Stock Prices, Shiller: ECY & Justification For Sky-High Stock Prices

What does history tell us about future returns when multiple valuation measures are high? The scatter chart below compares forward 10-year returns against four measures. They are Price To Sales, Tobin’s-Q, Shiller’s CAPE, and Market-Cap To GDP. (Read “Do You Feel Lucky” for more detail)

Justification Sky-High Stock Prices, Shiller: ECY & Justification For Sky-High Stock Prices

With expected returns falling between +2 and -3% over the next decade, meeting retirement goals will be challenging.

However, while valuations dictate long-term returns, it is all about the narrative near-term. Such was the point made by Shiller.

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