Swedroe: Key Market Value Metric Outdated

December 15, 2015

Larry Swedroe is a principal and director of research for Buckingham, an independent member of the BAM ALLIANCE. He was among the first authors to publish a book explaining passive investing in layman's terms—"The Only Guide to a Winning Investment Strategy You'll Ever Need." His most recent book, "Think, Act and Invest Like Warren Buffett," was released in early 2013. He will be giving a talk at Inside ETFs, “Is the Market Fundamentally Overpriced?” in Florida on Jan. 24.

ETF.com: You’re giving a keynote speech at Inside ETFs in Florida on Jan. 24, in which you will be questioning how markets are valued; specifically, the CAPE 10 metric. Let’s talk about that.

Larry Swedroe: It's important to begin by defining this metric that has been used to state that the market is overvalued, which is the Shiller cyclically adjusted price earnings ratio, or referred to generally as the CAPE 10. It's a metric that many use to determine if the market is fairly valued, undervalued or overvalued.

For the last four years or so, many gurus, including people like Jeremy Grantham of GMO, John Hussman of Hussman Funds, and even Nobel Prize-winner Robert Shiller himself, who this metric is named after, have been sending warning signals this metric has been giving off.

The long-term average—and here, we're talking about an average that goes back to the first data in 1870—is an average of about 16.6, and currently, CAPE 10 is registering about 26.

Clearly, it's way above the historical mean, which leads many people to say that the market is overvalued. It would be fairly valued if it were around the mean; and it would be undervalued if it were below the mean. It's certainly good to look at long-term data, but you have to ask yourself, are there regime changes? Are you really looking at an apples-to-apples comparison?

My talk covers six issues that lead me to conclude that the market, at the very least, is not dramatically overvalued. And it may not even be overvalued at all, just more highly valued, which doesn't mean it's overvalued.

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