Mark Hulbert: Stocks only slightly expensive

CHAPEL HILL, N.C. (MarketWatch) � U.S. equities are at most only slightly expensive � despite having risen nearly 30% just since last October and more than doubled over the last three years.

/quotes/zigman/3870025 SPX 1,374.02, +8.51, +0.62%

That is the surprising judgment of one of academia�s leading experts on stocks� valuation.

I say �surprising� because the expert in question is none other than John Campbell, chairman of Harvard�s Economics Department.

Campbell, you may recall, was the co-author (with Yale�s Robert Shiller) of the famous paper presented in November 1996 to Alan Greenspan and other Federal Reserve staff suggesting that stocks were entering a bubble phase. This, in turn, led Greenspan to give his now infamous �Irrational Exuberance� speech in December of that year.

I fully expected him to think stocks were, once again, at least within shouting distance of such bubble territory. After all, other analysts who also were prescient in the 1990s in warning about stock market valuations � such as GMO�s Jeremy Grantham � are issuing similar warnings today.

But not Campbell. On the contrary, he told me in a recent interview that stocks currently appear to be only �slightly expensive relative to their long-term average.�

The particular valuation measure that Campbell and Shiller championed to Greenspan is a �cyclically adjusted price-earnings ratio,� or CAPE. The denominator of this ratio is not trailing 12-month earnings, as is typically the case with the P/E, but average inflation-adjusted earnings over the trailing 10 years.

When the two professors presented their research to the Fed in late 1996, the CAPE stood at 27.6, the highest in U.S. history except for the months leading up to the 1929 stock market crash. Today, in contrast, the CAPE stands at 21.9.

To be sure, even at 21.9, the current CAPE is well above this ratio�s average over the 131 years for which there is historical data, which is 16.4. In fact, it is 33% higher.

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But the CAPE has been higher in recent decades than it was in the latter part of the 19th and early part of the 20th centuries. And when compared to its average level in these most recent decades, the current CAPE level doesn�t appear to be so out of line. In fact, it is only 12% higher than the average level of the last 50 years, and it is right in line with its average level of the last 30 years.

Furthermore, Campbell added, stocks may be justified in being priced at slightly above-average valuations. That�s because, he said, there appears to be no good alternatives. The bond market, for example, which is the only other asset class that could readily absorb even a portion of the trillions invested in the stock market, is particularly unattractive for long-term investments right now.

The bottom line? Perhaps not a screaming buy signal. But then again, not a sell signal either.

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