Renown Yale economist Robert Shiller recently issued two warnings that investors should carefully evaluate. Shiller is well known for predicting both the recent housing crash that began in 2006 and the tech crash in 2000-2001. While investors should always be skeptical of predictions, Shiller’s track record is such that his predictions are worthy of consideration. At present, he predicts that stocks are overpriced by approximately 40% and that housing prices could fall an additional ten to twenty-five percent over the next several years.
Shiller argues that stocks are overvalued because many analysts are relying on a fundamentally flawed concept, the current price-earnings ratio, to support their conclusion that stocks are cheap. While others argue that now is a great time to buy because stocks are “cheap,” Shiller argues that price-earnings ratios need to be considered over a period of years not just the most recent year. He believes that returns over time even out, so a year-by-year result may be extremely skewed in a positive or negative way. Right now, P/E ratios look low because profit margins are abnormally high. This distortion makes it look like a good time to buy when Shiller’s analysis indicates the opposite. Others argue that Shiller’s approach is outdated and that stock prices will get much higher over time.
Shiller also believes that the housing market remains in turmoil and “is harder to predict than the weather.” His primary concerns are that there are 11,000,000 homeowners that owe more on their homes than the homes are worth and that “the economy is sick right now.” He believes that financial innovation is the way to recovery but that there are real risks of further declines in the interim.
While there are skeptics about Robert Shiller’s opinions, history suggests that they should not be ignored.