Economic theory, as exemplified by the work of Andrei Shleifer at Harvard and Robert Vishny of the University of Chicago, offers ample reason to expect that long-term investment opportunities will never be eliminated from markets, even when there are a lot of very smart people trading.
This brings us back to the mystery of what’s driving the U.S. stock market higher than all others. It’s not the “Trump effect,” or the effect of the recent cut in the U.S. corporate tax rate. After all, the United States has pretty much had the world’s highest CAPE ratio ever since President Barack Obama’s second term began in 2013. Nor is extrapolation of rapid earnings growth a significant factor, given that the latest real earnings per share for the S&P index are only 6 percent above their peak about 10 years earlier, before the 2008 financial crisis erupted.
Part of the reason for America’s world-beating CAPE ratio may be its higher rate of share repurchases, though share repurchases have become a global phenomenon. Higher CAPE ratios in the United States may also reflect a stronger psychology of fear about the replacement of jobs by machines. The flip side of that fear, as I argued in the third edition of my book Irrational Exuberance, is a stronger desire to own capital in a free-market country with an association with computers.
The truth is that it is impossible to pin down the full cause of the high price of the U.S. stock market. The lack of any clear justification for its high CAPE ratio should remind all investors of the importance of diversification, and that the overall U.S. stock market should not be given too much weight in a portfolio.
Robert J. Shiller, a 2013 Nobel laureate in economics, is professor of economics at Yale University and the co-creator of the Case-Shiller Index of U.S. house prices. He is the author of Irrational Exuberance, the third edition of which was published in January 2015, and, most recently, Phishing for Phools: The Economics of Manipulation and Deception, co-authored with George Akerlof.