One Market Indicator Shrieks Sell While Two Others Suggest Stability

Morningstar’s John Rekenthaler examines three indicators of valuation for their possible predictive effect and tentatively concludes the market is likely to remain stable. He says the Shiller P/E ratio, which compares average inflation-adjusted earnings over the past decade to stock valuation, “appears to be shrieking, ‘sell!'” However, he notes that this indicator, with data back to the 1800s, “has been a wobbly indicator” and that “today’s P/E ratios are not your father’s P/E ratios.” On the first point, Rekenthaler observes that although the indicator may appear predictive when looking back at 1987’s Black Monday and 1929’s Black Tuesday, it also would have suggested danger in the mid-1950s.  Further, changes in accounting raise the possibility that the Shiller P/E ratio is “fatally compromised.”  Looking at Morningstar measures, which he notes have such short track records as to make them statistically unreliable, Rekenthaler suggests that current Shiller P/E numbers may not be reason to sell. Looking at dividend yields, he concludes “today’s signal looks benign.” Examining Morningstar’s Fair Value Measure, which incorporates human judgment and includes many data points, leads him to conclude that it “offers some comfort – or at least diminishes the possibility that a major crash is just around the corner.”  This is because the signal has “hovered in the same general range for several years” and “Morningstar’s analysts find today’s stock market to be as consistently priced as any they have encountered.”  The take-away lesson from this last indicator, for what it is worth, seems to be: “there are few obvious bargains, and equally few stocks that are overpriced.”