Morningstar | Analyzing the Rally

Morningstar had an interesting article today analyzing the rally since 10/3.  I pulled the following chart from the article.

Contrarian view from Silicon Alley Insider

This article provides an interesting but negative view on the future of stock returns.  Here are a few highlights:

Because the best predictor of long-term stock returns (emphasis on long-term) is the valuation of stocks at the beginning of the period.

Specifically, when stocks are expensive at the beginning of the period, the long-term returns are likely to be crappy.  And when stocks are cheap at the beginning of the period, the long-term returns are likely to be excellent.

A couple of years ago, at the depths of the financial crisis, when the world looked like it was headed to hell in a handbasket (or was already there), stocks were pretty cheap.  Returns since then have been excellent.

Now, however, stocks are expensive.

How expensive?

With the S&P nearing 1,300, stocks are trading at a 24X PE, according to professor Robert Shiller's cyclically-adjusted PE ratio (CAPE). This compares to a long-term average of about 16X. Thus, according to this measure (and several others), stocks are about 50% overvalued.

Read more: http://www.businessinsider.com/stock-forecasts-2011-1#ixzz1B7VqV7IT