Stocktake: Are US stocks in nosebleed territory?

US stock market valuations are in nosebleed territory, according to Nobel economist Robert J Shiller’s cyclically-adjusted price-earnings ratio (Cape).

Cape, which averages earnings over a 10-year period to smooth out the highs and lows of the economic cycle, is an imperfect measure in many respects. Shiller has implicitly acknowledged this by developing a new measure, the excess Cape yield, which considers both equity valuations and interest rates.

Nevertheless, Cape also has its uses, and the fact it recently topped 40 should give investors pause for thought. This is rare territory: only once, during the late 1990s dotcom bubble, has the S&P 500 traded on a Cape ratio of 40 or more. It topped out at 44 in March 2000, with stocks going on to endure a lost decade.

Valuation is not a timing tool. Cape first exceeded 40 in January 1999 but US stocks promptly soared 25 per cent over the next 14 months.

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However, the current Cape – and various other valuation metrics – suggest long-term returns will be subdued, at best. The last 10 years have been great for US investors but the next decade looks likely to be a much leaner affair.