The C.A.P.E. Crusader

Professor Robert Shiller, the Yale University, Nobel prize winning professor, announced last week, to the amazement of many, that the market could go up 50% from here. This abrupt about-face for a previously self-professed bear is notable for many reasons. My take-away is that the psychological market cycle has just reached an important milestone.

The construction of Dr. Schiller's CAPE (cyclically adjusted price earnings) ratio takes the trailing, inflation adjusted earnings as its denominator to arrive at a valuation gauge. The currently elevated level has frequently been used as a bearish argument against the market. As shown below, Only the Tech Bubble era was a period of higher valuation. Ominously, the bears will be quick to point out, we are at the same level as that which preceded the Great Depression.

CAPE Ratio

So how did Dr Schiller possibly explain his bullish statement? Simply put, he didn't. He didn't need to explain behaviour of the crowds. He just suggested that it happened before and it could happen again. The "bull market in pessimism" has lost one of its most celebrated adherents.

What is important here is not the esoteric ramblings of an ivory tower economist but the fact that market psychology must inevitably follow a pattern. That pattern unfolds, like it has since March of '09, from despair, and transitions through hope, optimism, and ultimately euphoria.

The "wall of worry" has lost one of its foundation stones. Stocks are no more expensive than they are cheap. The last trade prices all the rest. Price is what you can get the last buyer to pay. Value is not a timing tool.

Dr Schiller is just pointing out his expectations of the future of expectations. He's now a converted bull.

Deal with it bears. Until euphoria is more pervasive, the pain trade is higher.