In a recent interview, Dr. Robert Shiller justified “sky-high” stock prices by using a measure called the “Earnings CAPE yield” or ECY. To wit:
“There has been much puzzlement that the world’s stock markets haven’t collapsed in the face of the COVID-19 pandemic. Especially in the United States, which has recently been setting record highs for new cases. But maybe it isn’t such a puzzle. A measure we call the Excess CAPE Yield (ECY) puts the long-term outlook for the world’s stock markets in better perspective.” – Shiller
Before we dig further into his analysis, it is essential to review what we have previously stated about valuations. As discussed earlier in “Shiller’s CAPE – Is It Just B.S.”
The problem is that valuation models are not, and were never meant to be, ‘market timing indicators.’ The vast majority of analysts assume that if a measure of valuation (P/E, P/S, P/B, etc.) reaches some specific level it means that:
- The market is about to crash, and;
- Investors should be in 100% cash.
Such is incorrect. Valuation measures are simply just that – a measure of current valuation. More, importantly, when valuations are excessive, it is a better measure of ‘investor psychology’ and a manifestation of the ‘greater fool theory.’”
What valuations do provide is a reasonable estimate of long-term investment returns. It is logical that if you overpay for a stream of future cash flows today, your future return will be lower.
“Price is what you pay. Value is what you get.” – Warren Buffett