Risk of big stock drops grows: Robert Shiller
Based on his research of historical stock market valuations, Nobel Prize-winning economist Robert Shiller said Thursday he sees the “risk of substantial declines” ahead.
Even with the recent turmoil, which pushed the Dow industrials, S&P 500, and Nasdaq into correction last week and again this week, “the market is high now,” the Yale University professor told CNBC’s ” Squawk Box .”
As of Wednesday’s close, the Dow remained in a correction, despite strong gains. But the rally in the S&P and Nasdaq composite pulled those measures out of correction territory.
Shiller measures valuation with his cyclically adjusted price-to-earnings (CAPE) ratio, which looks at price divided by 10-year average earnings.
“The CAPE ratio right now is around 25. It’s high,” he said. The historic average is around 17, a level that would correspond with about 11,000 on the Dow and 1,300 on S&P 500. A retracement to those levels would represent more than 30 percent declines.
Shiller said he’s not saying that will happen, just the CAPE ratio serves as a “warning signal.”
In fact, based on history, the stock market could more higher because the CAPE has been much higher in the past before the air came out of the market, he said.
“The monthly CAPE ratio reached a peak of 44 in the year 2000 and that was followed by an important [market] drop. It went down to 13 and came back up to 27 in 2007 and it was followed by another drop,” he said.
“Nobody can really forecast the market accurately. But I think this is a risky time,” Shiller concluded-adding he personally has been reducing his portfolio’s exposure to U.S. stocks. “[But] everyone’s different. People need to look at their own risk situation.”