Tuesday, February 24, 2009

Shiller's P/E below fair value

Yale professor Robert J. Shiller, the author of "Irrational Exuberance," created one of the most useful and predictive measures of stock-market valuation: the cyclically-adjusted price-earnings ratio (CAPE).

As Professor Shiller explains here, the CAPE mutes the impact of the business cycle by averaging 10 years of earnings. It thus provides a good picture of the market's value regardless of where we are in the business cycle.

Professor Shiller's P/E has finally dropped below fair value for the first time in 15 years. The market's cyclically adjusted PE is now under 14X (compared to a long-term average of about 15X).

So is Prof. Shiller going all-in? No. He's waiting until the P/E drops below 10X, which it has done at major market lows in the past.

[via paraguay2es]

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