Allow me to answer these questions by two charts. The first one comes from the website of Nobel Prize winner Robert Shiller. It shows that the current Shiller PE10 is at 29.14. It is right at the level reached just before the Great Depression, and already far higher than the level just before the previous stock market crash in 2008. However, it still has ways to go before it reaches the peak achieved during the dot com bubble.
The second chart represents Shiller PE10 among global stock markets. It shows the relative valuation of stocks across the world. In this chart, US stocks are red hot and they are currently the most overvalued stocks in the world.
Why PE10 matters? Since PE10 is the best predictor of stock returns over the long run. Take a look at the scatter plot that correlatesPE10s to future ten year returns. As you can see, the higher the PE10, the lower the future return!
Is the market ripe for a fall? I don’t know since PE10 is weak in predicting short term returns. In 1997, then Fed chairman Alan Greenspan called the market “irrational exuberant” since the PE10 then was about at the level today. The market continued on rallying for another three years, pushing PE10 all the way to 44.16 before it collapsed more than 50%.
Now what? Stick to your investment plan if you have a globally diversified portfolio. Cheap foreign stocks will likely compensate expensive US stocks. Bonds will likely rally when stocks fall. If you don’t have a plan, you may want to talk to me.
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