Anxiety grows that US stocks are overpriced

OVER the five trading days between Aug 17 and 24, the US stock market dropped 10 per cent - the official definition of a correction, with similar or greater drops in other countries. The word "correction" puts a warm coloration on the harrowing decline, as if it were a sort of useful discipline imposed by a teacher on a student.

In fact, there have been 29 declines of 10 per cent or more in the market since 1950, according to a report by Yardeni Research, enough corrections to make this month's events seem part of a regular, healthy regimen. But there are reasons to question whether this was a quick, effective slap on the wrist, or if the market is still too overactive, and thus asking for a more extended punishment.

One way to measure stockmarket overvaluation is a modified price-earnings ratio developed from work that I did with John Campbell of Harvard University in the late 1980s. We call it the Cyclically Adjusted Price Earnings (Cape) ratio. High levels of Cape tend to be followed by poor stockmarket performance, not necessarily immediately, but over long intervals.