Robert Shiller, famed Yale prof who invented the “Shiller CAPE” index, is stating he is concerned about the current “high level” of the index, which in his mind indicates the stock market is very expensive and vulnerable to a pullback.
What’s the point? The media loves to focus on the CAPE index. The CAPE index stands for “cyclically adjusted price-to-earnings” ratio. It is essentially a trailing 10-year P/E ratio. We are a little amused at all the focus the media places on the index because we believe, as do others, that the index is flawed. Why is it flawed? 1) It does not normalize earnings for extreme cyclical swings (which can distort P/E valuation); 2) it does not normalize for interest rates (which are extremely low now); and 3) it is totally backward looking, i.e. the information captured in the CAPE index is already pretty fully discounted by the market which is forward-looking, not backward looking. While the media likes to make a big deal about the CAPE index, we believe its usefulness as a valuation tool is fairly limited and certainly cannot be looked at in a vacuum. That said, we are not insensitive to current market valuations which we believe are moderately high, but most likely have room to move somewhat higher over the next couple of years.