Under What Circumstances Should You Worry That the Stock Market Is “too High”?: The Honest Broker for the Week of August 16, 2014

Using valuation measures for market timing doesn't work so we're left with stuff like Zürich's Didier Sornette's thinking, links after the jump. Quick spoiler: no crash this month.
(he said with 14 days to go)

Brad Delong at the Washington Center for Equitable Growth:

Robert Shiller: The Mystery of Lofty Stock Market Elevations “The CAPE ratio, a stock-price measure I helped develop…

…is hovering at a worrisome level…. Above 25, a level that has been surpassed… in only… the years clustered around 1929, 1999 and 2007. Major market drops followed those peaks…. We should recognize that we are in an unusual period, and that it’s time to ask some serious questions about it…

The first question I think we should ask is: how damaging in the long run to investor portfolios were the major market drops that followed the 1929, 1999, and 2007 CAPE peaks? The CAPE is the current price of the S&P index divided by a ten-year trailing moving average of its earnings: the CAPE looks back ten years to try to get an estimate of what normal earnings are and how stock prices deviate from them. Let’s look ahead and calculate ten-year forward earnings to get a sense of what signals the CAPE sends for those of us interested in stocks for the long run.

When we do that, we find that we cannot calculate a ten-year return for the 2007 CAPE peak of 27.54–we still have three years to go. But over the past seven years the S&P has produced an average annual real return of 5.2%/year: not too shabby. The ten-year average real return from the 1929 peak of 32.56 was 3.3%/year: you were in a real world of hurt if you panicked and sold or had to sell in 1931-1934, but not if you hung on. Only the 1999 peak was followed by long-run return disaster: a ten-year average real return of -2.1%/year because you would have been selling at the bottom in 2009–but even then if you had hung on until today your average 14.5 year real return would be +2.7%/year.

If you are not an investor in the stock market for the long term, you can easily get into a world of hurt with a position in the S&P composite (and an even bigger world of hurt with an undiversified portfolio). Look at the one-month and one-year return distributions:

You can lose a fifth of your money in a month. You can lose more than half your money in a year. And you can do those things as well with a CAPE of 15 as with a CAPE of 40. If you are not in stocks for the long term, your stock portfolio should not consist of money that you cannot afford to lose....

...MUCH MORE

In 2013's "UPDATED--Commodities and High Frequency Trading: Prices Being Driven By Price Moves Rather Than Fundamentals" after I called him a flake we linked to Sornette's "Quantification of the High Level of Endogeneity and of Structural Regime Shifts in Commodity Markets" (56 page PDF)

That post also linked back to:

Econophysicist Predicts Date of Chinese Stock Market Collapse--Part II
Forecasting Financial Crashes: The Ultimate Experiment Begins

And FT Alphaville's wonderfully titled "Dragon-king of the outlier events".

See also:
"The Illusion of the Perpetual Money Machine"
Innovation as a Social Bubble: The Example of the Human Genome Project

Here's his latest via SSRN:
Power Law Scaling and "Dragon-Kings'' in Distributions of Intraday Financial Drawdown

And via Google News:
"Didier Sornette: Wir sprechen von Blasen, wenn wir ...

Ad-Hoc-News (Pressemitteilung)-Aug 8, 2014

€uro am Sonntag: Herr Sornette, wie definieren Sie eine Blase? Didier Sornette: Wir sprechen von Blasen, wenn wir superexponentielles ...

And more at his ETH Zürich Chair of Entrepreneurial Risks homepage,