Are stock markets, especially the US market, in a bubble that is sure to pop? The answer depends on prospects for corporate earnings and interest rates. Provided the former are strong and the latter ultra-low, stock prices look reasonable.
The best-known measure of market value — the “cyclically adjusted price/earnings ratio” of Yale’s Nobel laureate, Robert Shiller — is indeed flashing red. One can invert this metric, to show the yield: on the S&P Composite index, this is just 3 per cent today. The only years since 1880 it has been even lower were 1929 and 1999-2000. We all know what happened then. (See charts.)
Another price is also exceptionally low by past levels: interest rates. The short-term nominal interest rate is near zero in the US and other high-income economies. US short-term real interest rates are about minus 1 per cent. Real yields on US 10-year Treasury-inflation-protected securities are minus 1 per cent. In the UK, yields on similar securities are about minus 3 per cent.