May 24, 2011
The reason, he said, is that “they don’t make more farmland.”
He said there was a psychological error that led to the bubbles in commercial and, in particular, residential real estate. People thought buying a house was the same as buying land. “That was a big mistake,” he said. According to the National Association of Home Builders, land represents about 20% of the value of the average US home. Most buyers still don’t understand this, he said.
Farmland prices, however, are benefitting from food inflation and what he called a “food crisis.” “That’s what is driving our CPI,” Shiller said.
“Watch out,” he said. “These things develop and bubbles form. They overshoot and then they collapse.”
Shiller is not the only one who has commented on the rise in farmland prices. James Grant, in his publication Grant’s Interest Rate Observer, has devoted several recent articles to the phenomenon, and has said that farmland buyers are now often speculators rather than farmers.
Projected returns for equities
Shiller has popularized the use of cyclically adjusted price-to-earnings ratios, which smooth out the effect of changes in earnings over the course of the business cycle by averaging them over the trailing 10 years. Graham and Dodd pioneered this method in the 1930s.
When adjusted in that manner, Shiller’s P/E ratios are highly predictive of returns for the stock market over the long term – at least a 10-year horizon.
Right now this P/E ratio is 23, he said, which is “high but not super high.”
“I figure that the expected return for the stock market over the next 10 years is between 2% and 3% a year,” he said, “and that's including dividends.”
A crash like we had in 2000 in not imminent, Shiller said, and he is more concerned about a “stagnating of market prices over the next decade.”
Nobody can forecast very well, he cautioned. “My best guess is that we would expect disappointing, but not terrible returns.”
Despite yields of less than 1%, Shiller said he likes TIPS, because that 1% yield will be adjusted upward if there is inflation. “It’s really not so bad if you compare it with the outlook for the stock market over the next 10 years,” he said, because TIPS are significantly less risky than stocks.
“Stocks do have a chance of doing really well,” he said. “But we are a little too much on the high side in terms of price-to-earnings ratios to be comfortable.”
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