A popular media refrain of late suggests that stocks are overvalued compared to historical benchmarks. The Wall Street Journal, for instance, recently opined that “Stocks are expensive (and not just the big ones)”. Meanwhile, The Economist declared, “American stocks are at their most expensive in decades”, and MarketWatch concurred, affirming that “U.S. stocks are expensive by almost any measure.”
However, there is no evidence that any single valuation metric has consistently demonstrated the ability to predict whether stocks are “mispriced,” either individually or in aggregate. Market prices, in fact, embody the collective wisdom of millions of participants, including investors and firms, all with their financial well-being on the line. In this fiercely competitive arena, no piece of pertinent information escapes scrutiny. Stock prices themselves emerge as the most reliable gauge of what they ought to be. This is the central proposition of the Efficient Market Hypothesis (EMH), which posits that market prices reflect all publicly available information and, as such, represent the best estimate of their true worth.
EMH has demonstrated remarkable resilience, enduring over five decades of review from both money managers trying to beat the market as well as academic researchers. It remains the preeminent framework for understanding how securities are priced in the market and why market timing is unlikely to succeed. Investors should accept prevailing market prices as the most reliable estimate of the market’s true value.
However, while EMH is robust, it is not conclusive. Financial economics, as a social science, constantly faces rigorous intellectual analysis. It is important to explore alternative models for assessing market valuations that may offer insights into potential turning points in advance. In this context, our focus now shifts to the Shiller Cyclically Adjusted Price-to-Earnings Ratio (or CAPE Ratio), a widely referenced metric.1 This model draws upon the current value of the overall US stock market relative to the market’s previous ten years of aggregate inflation- adjusted earnings,2 offering an intriguing perspective for market analysis.
Also In This Issue
Value Stocks: Down But Hardly Out
A Perspective On Relative Stock Market Valuations
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Asset Class Investment Vehicles
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