Simple Financial Explanations in the Media

Robert Shiller had an excellent article in the NYTimes where he comments on the cyclically adjusted price-to-earnings (CAPE)* ratio “that [he] has been advocating for decades” in the context of the current market.

At a value of 23 he writes that the market might still look slightly expensive when compared against the historical average of 17 (since 1881).  He argues that returns have tended to be moderately positive over 10 year periods from this current level. But he also questions whether or not this crisis might make investors more risk averse in the years that follow:

“I worry that the present anxious situation may stay in the collective memory for decades, much as the stock market crash of 1929 did. That could make people more risk-averse, possibly portending lower valuations on the stock market.”

*Shiller defines it as “real stock price divided by a 10-year average of real earnings, sometimes called the Shiller P/E.”

Click on the link for an excellent read with additional data points for the CAPE.

Neil Irwin provided a very effective and simple definition of the price-earnings ratio in a recent NYT article encouraging investors to think logically about investing in the long term. The definition provided follows:

“Typically, stock analysts think of valuations in terms of the price-earnings ratio, but it can be clarifying to invert it. So, for example, at the record market high on Feb. 19, this earnings-price ratio was 3.1 percent for the S&P 500, meaning that every $100 invested in an S&P index fund bought interests in companies that accounted for $3.10 in profits over the previous year.”

Click on the link below for an article that uses this definition to help readers think about how to approach a falling market.