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As Dow flirts with 14,000, are stocks cheap?

January 29, 2013|By Andrew Tangel
  • Stocks have seen a recent rally, and the Dow Jones industrial average is again flirting with 14,000. But are stocks cheap or expensive?
Stocks have seen a recent rally, and the Dow Jones industrial average is… (Richard Drew / Associated…)

NEW YORK -- Stocks may be near record highs, but they are not terribly expensive, at least by one measure.

Last week the broad Standard & Poor's 500 index closed above 1,500 for the first time in five years. This week the Dow Jones industrial average has been flirting with 14,000, a level it hasn't seen since October 2007.

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In early trading Tuesday, the Dow added 22 points, or 0.2%, to 13,905.

Stocks are a bit pricey relative to their earnings, but are nowhere near the overheated levels they've seen before, said Robert Shiller, a famed Yale University economist who identified the stock market and housing bubbles of the last decade.

Shiller, who may be best known for a widely reported index tracking U.S. house prices bearing his name, also created an index to track whether stocks were cheap or overpriced.

His CAPE index -- which stands for cyclically adjusted price-to-earnings ratio -- factors in 10 years' worth of earnings. He has collected data stretching back to 1871.

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As of Jan. 16, the broad Standard & Poor's 500 index had a CAPE of 22.24 -- higher than the average over the last half-century of 19.52.

“It is somewhat high,” Shiller said, but "not shockingly high.”

His index's reading is only half of its reading of 44.2 in December 1999, amid the tech bubble that later burst.

Stocks are also cheaper than the last time the Dow hit 14,000, according to Shiller's index.

In October 2007, the index was at 27.31. Back then, George W. Bush was president, the investment banks Bear Stearns and Lehman Bros. still existed and the economy hadn't yet fallen into recession.

Shiller said historically low interest rates, which are making other investments less fruitful, were probably  fueling the current rally. The Federal Reserve has been pumping money into the economy to lure investors into riskier assets like stocks.

“One would, just based on interest rates alone, want to have more in the stock market,” Shiller said.

Rising home prices, and better-than-expected corporate earnings may also be lifting spirits on Wall Street. Resolving the fiscal cliff -- and uncertainty over capital gains taxes -- likely also helped.

“There does seem to be some rekindling of investor sentiment,” Shiller said.

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