Robert Shiller, Sterling Professor of Economics at Yale, was speaking on the 12th November at an event organised by Ossiam, an affiliate of Natixis Investment Managers, which specialises in quantitative asset management. Professor Shiller was in conversation with Doctor Christian Keller, Head of Economics Research at Barclays, about the macro-economic issues driving valuations. The event was hosted by Natixis IM in its London office and was well attended by journalists and financial professionals.

The wide-ranging session covered everything from the impact of President Trump and trade tensions between the US and China to the repercussions of ECB monetary policy in Europe. The latest twist in the Brexit saga inevitably featured once or twice, too.

Economist and Bartleby columnist Philip Coggan ably chaired the session. He kicked-off proceedings by asking Shiller what the CAPE – Cyclically Adjusted Price to Earnings – ratio says about valuations today and how they compare to stock prices at previous moments in history.

Rise and fall

The Shiller CAPE ratio – which can generally be applied to broad equity indices to assess whether the market is undervalued or overvalued – hit 32 times 10-year average earnings in September. The last time it went that high was June 2001, having peaked near 45 in mid-2000, just as the dot-com bubble was about to burst.

Using the theory that low CAPE ratios generally indicate high future returns, while high ratios provide an overall contraction signal, some commentators have come to see the Shiller CAPE as a useful timing signal for market turning points.

But that’s not quite right, according to Shiller, who co-created the ratio that bears his name. Indeed, Shiller has been keen to play down precedents of another market crash based on the Shiller CAPE ratio being high, pointing out that it has since fallen back to under 30 and is likely to fall further.

“This isn’t dismal, it is not in crash mode,” he said. “It just says that earnings are not as high for the US… and it will gradually revert to a lower CAPE ratio, as it has done historically.”

CAPE fear?

Referring to the way present day valuations and earnings growth have been linked to explain a higher price to earnings ratio, Shiller told the audience: “I’m sceptical because I’ve looked at historical earnings and they have this jagged appearance. We’re on a real upspike recently and it has something to do with things like Trump and his tax cuts, and labour movement has weakened…

“But these are things that fluctuate through time… people who think that markets should be so high now because of recent earnings growth are just forgetting about history.”

According to Shiller, the market is almost unforecastable over short intervals of time because there’s an overall narrative that is really driving it. “From the roaring 1920s to the Great Depression, narratives have always been driving markets”, he said.

He went on to argue that the current narrative has been successfully captured by President Trump, “whatever you think of him”. This theme of storytelling as a driver of markets forms the subject of Shiller’s upcoming book, ‘Narrative Economics’.

He used the example of his study into US house prices to illustrate his point – the data from which is explored in his earlier book, the New York Times bestseller ‘Irrational Exuberance’. “We’re currently in one of three major housing booms”, he said – the others being the period 1997-2006, which preceded the global financial crisis, and 1943-51, characterised by the ‘baby boom’ generation.

So, what is driving the current period of high house prices? According to Shiller, “It’s not building costs, it’s not interest rates. It’s not population growth… it’s not exclusively Donald Trump, because most of this current boom predates him… it’s the narrative at this point that is encouraging high prices.”

And how long will it last? “Now, there’s the real question,” he quipped.


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