Yale Economist Robert Shiller advises savvy investors that you shouldn’t give into temptation to dump your stocks just because valuations are high.
"If I was giving you advice: Do nothing. Don't pull out. Don't go in," the Nobel laureate economist recently told CNBC.
Investors are dialing back hopes that President Donald Trump will swiftly enact his agenda, with a Thursday vote on a healthcare bill a litmus test which could give stock investors another reason to sell.
U.S. stocks rallied after the November presidential election, with the S&P 500 posting a string of record highs up to earlier this month, on bets that the pro-growth Trump agenda would be quickly pushed by a Republican Party with majorities in both chambers of Congress.
Meanwhile, Shiller’s valuation gauge, the cyclically adjusted price-to-earnings (or CAPE) ratio, is at levels it surpassed only in 1929 and surrounding the dot-com bubble. Its elevated level indicates the market is "highly priced in the short run," he told CNBC.
The CAPE’s level is determined by comparing the S&P 500's current level to average earnings over the previous 10 years, adjusted for inflation.
"It's already high enough to make me nervous ... the CAPE ratio is one of the best indicators, or I might say the best indicator, if you look at one alone, for the outlook in the long run for stocks. It's high now; and in the past when it's been this high, it hasn't done well," Shiller said.
"I'm not going to plunge into the market. I'm holding steady; I'm not pulling out, either," he repeated.
"I still suspect there is more left in the Trump rally," he said. "I'm just playing the game a little bit here, and thinking, in the shorter run, this rally — I can start to see reasons for it, and I'm thinking about those reasons," he said.
He said the recent stock surge is "not a typical bull market with a lot of excitement," he said. "It's more of an anxious market where people are afraid of secular stagnation, of losing their jobs to foreigners, or to computers. And they have kind of a wishful-thinking bias about investments like stocks. It's the only way I can understand it."
Strategists have been cautioning for weeks that markets are pricing in a scenario where nothing goes wrong with Trump's agenda, Reuters reported.
Investors are paying $18.10 for every dollar in earnings expected on the S&P 500 over the next 12 months, near the most expensive U.S. stocks have been since 2004.
"This is really about the fact that the market is pricing in too much certainty on a number of accounts," said Julian Emanuel, executive director of U.S. equity and derivatives strategy at UBS Securities. "Even if you got the positive vote, there's still the residual knowledge that the agenda will be difficult to get through the Senate."
While investors and strategists have said they do not see an immediate threat to the eight-year-old bull market, there is a risk of a 5-to-10 percent drop. Only a bear market (a 20 percent decline) would put an end to the bull.
Meanwhile, Newsmax Finance Insider Lance Roberts recently took Shiller's CAPE to task.
"But the debate over the value, and current validity, of the Shiller’s CAPE ratio, is not new. Critics argue that the earnings component of CAPE is just too low, changes to accounting rules have suppressed earnings, and the financial crisis changed everything," Roberts wrote for Newsmax Finance.
Roberts explained that this was a point made by Wade Slome previously:
“If something sounds like BS, looks like BS, and smells like BS, there’s a good chance you’re probably eyeball-deep in BS. In the investment world, I encounter a lot of very intelligent analysis, but at the same time I also continually step into piles of investment BS. One of those piles of BS I repeatedly step into is the CAPE ratio (Cyclically Adjusted Price-to-Earnings) created by Robert Shiller.”
(Newsmax wires services contributed to this report).
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