A recent article from the Wall Street Journal spoke about the dangerously high valuation of companies and what is causing it, as well as the potentially negative outcomes for the economy. According to Robert Shiller (a Nobel laureate from Yale) the economy definitely has a bubble feel to it right now, with P/E ratios higher than they ever have been. Shiller created a cyclically adjusted stock valuation model that divides the P/E ratio by the 10 year average of real EPS. He notes that the ratio is currently at 27, a number that has only been reached three other times in the history of the stock market. Those three years? 1929, 2000, and 2007.
Shiller maintains that this is not cause for panic though, because those previous “bubbles” were characterized by grossly inflated expectations of gains that are absent in the current market.
Jeremy Siegel takes the opposite approach, claiming that stocks are indeed slightly overvalued, but the higher price level is more than justified by the fact that interest rates are expected to remain extremely low. According to Siegel, these low interest rate expectations are enough to push the Dow into the 20,000 range before we see any real market contractions. While it appears that there is still profit to be made from investing in these relatively expensive stocks, investors should lower their expectations to the 4-5% range until the economy inevitably contracts and offers higher growth potential.