Why irrational exuberance does not explain this stock market

Yahoo Finance

Are stocks overvalued? That's a question investors have been asking for several years since the stock market has posted huge gains while the economy has grown moderately.

One measure cited showing that overvaluation: the CAPE ratio, created by economists John Campbell and Nobel prize-winner Robert Shiller. This cyclically adjusted price-earnings ratio now tops 25 -- a level that occurred only around 1929, 1999 and 2007.

But, to quote the entertainer Harvey Fierstein in Torch Song Trilogy, "Is that so wrong?"

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Apparently it may be. The CAPE has topped the 20-level mark for most of the past 20 years, Shiller revealed in The New York Times on Sunday. So is it a legitimate measure of stock market valuation, and why is it so high?

Aaron Task, editor-in-chief of Yahoo Finance, says declining bond yields during most of the past 20 years may explain why the CAPE ratio has reached such lofty levels. "If yields keep falling, stocks look more attractive," says Task. "You've got to get some return from somewhere." The 10-year Treasury yield midday Monday was 2.37%.

Related: "It looks like a peak": Robert Shiller's CAPE is waving the caution flag

Shiller wrote in The New York Times that the drop in bond yields may be due to investors' "anxiety about the future," primarily about losing their jobs "which might push them to try to make up for these potential shortfalls by investing in stocks and bonds -- even if they worry that these assets are overvalued."

Related: Why today's valuations are worse than in 1999

But the "real answers," wrote Shiller, might be "irrational exuberance," which was largely blamed for the outsized dot.com rally in 1999-2000 and "has always faded before."

Task doesn't buy that theory. "Who is out there banging the table and saying 'you've got to own stocks. They're fantastic. Buy them here.'... Until we get to a place where everyone says you can't lose in the stock market, then call me and talk about irrational exuberance."

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