Stocks are setting record highs, U.S. unemployment has retreated toward six-year lows and financial crises in North America, Europe and much of the developing world have faded.
So why is everyone so glum right now?
“I am not throwing in the towel but I’m not about to throw caution to the wind, either,” David Rosenberg, chief economist and strategist at Toronto-based Gluskin Sheff + Associates, said in a blunt note on the global economy, released earlier this week.
“This is an acknowledgment of how unusually high the level of uncertainty is.”
Robert Shiller, the Nobel Prize-winning Yale economist, also stirred things up in a recent New York Times article by calling today’s stock market valuations “worrisome” and comparing them to dangerous peaks in 1929, 1999 and 2007.
“Major market drops followed those peaks,” he said, adding that individual and professional investors “are beginning to worry.”
For some observers, worries are good. Stocks, they say, climb a wall of worry.
These observers like to point out that this has been the most hated bull market in history – defined by unusually high levels of caution and fear from the get-go in 2009, when stocks began to recover from multiyear lows.
And just look at what stocks have done with this investor reticence: Five-and-a-half years into the bull market, the S&P 500 has nearly tripled and Canada’s S&P/TSX composite index hit record highs this week.
But many of today’s worriers aren’t bitter, sidelined investors who have missed out on spectacular gains. Rather, they are seasoned pros who have seen these conditions before and are growing increasingly concerned that the risks in the stock market outweigh the rewards.
No one is suggesting that investors should sell all their stocks, but rather prepare themselves for disappointing returns ahead – and the possibility of the sort of demoralizing dip that can challenge our long-term commitment to the market.
‘We are in an unusual period’
Mr. Shiller is about as far away as you can get from a table-pounding blowhard who sees doom and gloom around every corner.
He is a soft-spoken academic whose meticulous research draws on market data going back more than a century. In place of forecasts, he raises concerns – often with a chuckle – and his views are usually accompanied by questions and caveats.
Yet his track record for spotting trouble has raised his profile from an Ivy League professor to a voice of reason that can’t be ignored.
His book Irrational Exuberance, published in early 2000, eviscerated the hokum that drove the dot-com bubble at a time when many analysts and strategists were remarkably comfortable with stocks trading at 150-times earnings.
He showed similar prescience with his warnings about the U.S. housing market before its collapse triggered the global financial crisis and Great Recession.
In previous remarks about the stock market, Mr. Shiller has sounded cautious but hardly alarmed by stock prices – but that is changing.
His preferred approach to gauging the risks in the stock market is to compare the current level of the S&P 500 with corporate earnings averaged over 10 years and adjusted for inflation. He calls this the cyclically adjusted price-to-earnings ratio, or the CAPE ratio, which attempts to smooth out fluctuations in the business cycle.
The CAPE ratio’s long-term average is about 15. But as he pointed out in his New York Times article, the ratio has risen above 25 following this summer’s market surge, a level surpassed only three times since 1881.
All three just happened to occur before terrifying downturns. The crash of 1929 sent U.S. stocks tumbling 89 per cent over the next four years; the tech wreck of 2000 sent the S&P 500 down 49 per cent by 2002; and the financial crisis sent the index down 57 per cent between 2007 and 2009.
Mr. Shiller, whose article is free of bear-market gore, is not hitting the panic button. Indeed, his observations are in keeping with his here-are-the-facts approach to market timing.