Robust economic data and optimism over US tax reform have driven the S&P 500 to a series of record highs. Some now believe that US stocks are looking a little overbought, but Capital Economics doesn't expect a bubble to burst in 2018.
Analyst John Higgins notes, however, that the Shiller cyclically-adjusted price earnings (CAPE) ratio for index has climbed to near 32.
He says: "The last time it rose to such a high level was in the late 1990s, shortly before equity prices in the US plunged."
But this is no reason why investors should immediately switch their tactics to short US stocks in the coming weeks.
A better CAPE measure?
Higgins notes that the main demoninator for the CAPE ratio is a ten-year average of earnings per share measures that is still being depressed by the last recession of 2009/10, which resulted in widespread asset writedowns.
A more accurate measure would be an average of operating earnings per share - "a better guide to underlying earnings", says Higgins. This is higher with the result that Shillers CAPE is roughly 5 points lower when this measure is chosen for the denominator. (See chart)
Moreover, says Higgins, earning per share have grown significantly in the US since the recession, so they are higher now than on average during the prior decade. Considering this, the operating EPS CAPE ratio would be as low as 20.