After a healthy bull run since the Great Recession ended five years ago, some market watchers are warning that stock investors are in for a much rougher ride.
That's because some key measures of stock values are flashing signs that stock prices may have gotten ahead of themselves. A lot, though, depends on how you read the tea leaves, and which leaves you choose to look at.
Some of the strongest warnings that stocks are overvalued lately have been coming from Nobel Prize-winning economist Robert Shiller, who told CNBC earlier this month that he sees the "risk of substantial declines" ahead.
Shiller bases his bearish view on a long-term analysis of the relation between stock prices and earnings, the basic driver of stock values. In order to smooth out the effects of short-term market gyrations, Shiller takes the total earnings for the companies in the widely watched Standard & Poor's 500 index, averages them over 10 years, and adjusts for inflation. The result is a measure called the cyclically adjusted price-to-earnings, or CAPE, ratio. And the CAPE, he said, is pointing to a big drop in the overall stock market.
Shiller figures the current CAPE ratio—even after the recent market pullback—is around 25. That's much higher than the historic average of around 17, which means that stock prices would have to fall sharply for the ratio to revert back to that average level. If it did, stocks would fall by some 30 percent, with the Dow Jones industrial average dropping to about 11,000 and the S&P 500 diving to about 1,300.