Generally speaking, there's two ways for the stock market to appreciate. Either through earnings or the PE multiple going up. Naturally, if you buy a stock at 10 PE and the PE jumps to 15, then you've made a 50% profit if earnings stayed flat. Similarly, if earnings increase 50% then you'll make a 50% profit if the PE multiple stays flat.
Problem is since 1990, 55% of stock market gains have been through PE expansion. (Using inflation adjusted data from http://ift.tt/1HG96Ei and http://ift.tt/2jkDNh3.) Since 1990, price has gone up 5.37% a year. Meanwhile, earnings have only gone up 3.28% a year. To put that in perspective, from 1945 1944 to 1990, they went up 2.55% and 2.46% p.a. respectively. (Remember, these are all inflation adjusted., i.e. real growth rates.)
Here's a graph I made: http://ift.tt/2kbU7zg As you can see, historically, the 10 year median PE kind of cleanly cycles from a high of 18 to a low of 9 or 10. Then in the late 90's it "should" have peaked, but it didn't. It just kept going up and it's stayed above 18 ever since. In fact, we never had a 10 year median PE above 19 before 2000. Now we've had it 16 times.
See, when the Fed dropped interest rates to zero and dumped unholy amounts of money into the economy, everyone, including myself, thought we'd have high inflation. But the CPI has stayed low. Really low. http://ift.tt/1JGhA0R In 2014 Bernanke quipped that "the problem with QE is that it works in practice, but it doesn't work in theory." And since unemployment numbers have been good http://ift.tt/2kbWvFZ and the stock market has been going up, we all kind of assumed that, hey maybe this Bernanke guy knows more about economics than we do.
But here's a troubling thought. And Im not the first to have this, there's actually a really good, if libertarian-leaning documentary on Netflix called "Money for Nothing" that kind of inspired this line of thinking. But what if we haven't seen inflation in the CPI simply because the money (i.e. QE) didn't go to the consumers. It went to the banks. What if we are experiencing dramatic stock market inflation?
Well I think most of us know that low interest rates are propping up the stock market, but by how much? Well. If the stock market had a more historically average PE multiple of 15, for example, the stock market would tumble over 40% to around $1,300.
Now keep in mind, I'm not predicting a massive 40% drop off. I'm just saying that the PE multiple should revert to mean eventually, and 25 to 15, no matter how gradual, is a bit of a headwind. Even if it took 20 years to go from 25 to 15, with earnings growing at a real 2.66% a year like they have been since 1990 1989, we'd ended up in 2036 with a price just shy of where it is today: around $2,260.
Course, this is all ignoring dividends. Which isn't lost on me. Even if the SP500 went flat over the next 20 years, you'd still get your dividends. And in case anyone is wondering, dividend yield has somewhat unsurprisingly ran counter to the PE. Here it is: http://ift.tt/2jkOrV5
And the payout ratio (Dividends / Earnings) has been declining http://ift.tt/2kbSRvH which makes me curious about the effects of share repurchases. (Dividends and share repurchases are the two ways companies can return cash to shareholders.) Share repurchases make the stock price rise without affecting earnings, so that will translate to PE multiple expansion. Unfortunately, for all the awesome data http://ift.tt/1uW5zPK Mr Shiller has provided, they don't track share repurchases.
Well pardon me for jumping off my train of thought with a rather unsatisfactory conclusion, but I have to get to bed. Hopefully I've given you something to think about.
tl;dr: this guy thinks pe is too high
edit: and this is a minor, anal retentive detail, but when i say a year, Im actually mean as of Dec 31st of that year.
Submitted January 24, 2017 at 12:24AM by Wild_Space http://ift.tt/2kbUCcq
