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Is the US equity market overvalued?  

According to Nobel Prize winner Robert Shiller, the US equity market is overvalued by 70%. This conclusion is based on his CAPE-model. This model adjusts the P/E of US companies according to the relative economic cycle. There have only been three times in history when equities have been more expensive than today, and more importantly, each time a severe correction followed in the coming quarters. Yet, here is the paradox: he answers the question of whether one should take profit and leave the market with the following answer: "There is still an opportunity to invest".

Shiller, a Yale professor, says that there a number of important facts that match historic events. He believes the foundation of today's overvaluation lies in the ultra liberal monetary policy of The Fed and investors' diffuse anxiety about the future. And argues that the overvaluation is not only visible in the equity market but also in the bond market. Despite this, pockets of fair valued market segments do exist: a) in the US in the Technology, Energy, Healthcare, and Industrials, and b) in Europe in the Energy, Technology, Telecom and Utilities.

Shiller goes one step further and warns investors that they are setting their expectations too high.  He believes that for the next 10 years the annual average real return of the US market will not exceed 2.5% p.a. If this proves true, then either the stock market is going to see relatively low annual average returns, or there will be a relatively high rate of inflation.

He is, however, more optimistic about the European equity market, which he considers to be at a historic average, and he particularly favors the European peripheral market and the UK. Yet, he says that Europe lacks confidence in its own system, and therefore, now is an opportune time for its governments to proceed with a real policy to stimulate the economy. He argues that when there is a lack of confidence, people save their money rather than consume or invest. The result of such a trend could be a repetition of the 1930s, which resulted in the destruction of the economy. While we believe this could be particularly true of France and some of the Nordic countries, on the positive side, deep reforms are currently being rolled-out in countries such as Italy, Spain and Portugal. Also, the fact that Germany is pulling together new allies (along the North-South axis) is a powerful sign that after more than 20 years of unfruitful German-French efforts to understand each other and to make Europe the world's powerhouse, things are now moving in a new direction.