Let’s say that as far back as you can remember, an eight-pack of a beer you like has cost around $17. But in the last few years, the price has soared, and now the same beer costs $31, even after adjusting for inflation.

Questions come to mind: If the eight-pack has historically cost an average of $17, what makes it worth $31 today? Has the product changed? Are there more buyers? Fewer sellers? What’s going on here?

I am, of course, talking about the value of the S&P 500 index as measured by the Shiller ratio, named after its developer, economist and Nobel laureate Robert Shiller. He has espoused a price-earnings ratio that includes 10 years of data, adjusted for inflation, instead of the usual 12 months. It’s long-term average (since 1881) is 16.8. On November 3, 2017, it stood at 31.57, according to multpl.com. (I’m citing the Shiller p/e ratio, because its long-term look provides a more accurate measure of pricing than the commonly cited short-term ratio.)

In plain English, investors have believed the average stock in the S&P 500 was worth 17 times average earnings; now they believe it’s worth 31 times earnings. Why? There are reasons, to be sure: the pending tax bill, which seems to favor corporations; low unemployment; good corporate earnings; and a dramatically rising stock market. Why worry?

An ominous precedent
The point that bothers me is that the Shiller ratio has been higher than 31 only once in the last 100 years—in December 1999, an event followed a few months later by a 49 percent plunge in the S&P 500. That’s not a typo. Nearly half the value of the S&P 500 was wiped out in just a few months–reason enough to worry about a sky high Shiller ratio.

Another worry: In 1980 global financial assets stood at 110 percent of global domestic product. Today, they amount to 330 percent of global domestic product. This increase amounts to a form of macroeconomic inflation, because it means there has been a huge expansion in the amount of paper representing actual production.

That said, it’s possible we’re in some sort of new era, where stocks are worth far more than they used to be–possible, but I think not likely.

The U. S stock market has been powered by similar good news many times before, without (with one exception) causing the Shiller ratio to soar north of 30. What, I have to ask, is so different about the current good news? I don’t see it. What I do see is an excess of hope.

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