MANY a gloomy pundit, Buttonwood included, has been tut-tutting about equity valuations in America for the past year or two. After all, by historical standards, they are high. Yet there is no shortage of cheerleaders to explain why equities are not such a bad deal after all. A notable one now is Olivier Blanchard, until recently the chief economist of the IMF. He and Joseph Gagnon, a colleague at the Peterson Institute for International Economics, a think-tank, have published a blog post* arguing that American equities are not overvalued, in particular compared with the values seen ten years ago.
Alas, there is reason to quibble with the data underpinning the post. It refers to the cyclically adjusted price-earnings ratio compiled by Robert Shiller of Yale University, which averages profits over ten years. Mr Shiller has calculated the ratio back to 1881. The average since then is 16.7, so the current ratio, 24, suggests shares are 44% overvalued by historical standards. But the Peterson post compares current valuations with the 60-year average of 20, arguing that accounting and tax changes…Continue reading