Not Expensive vs cheap

Barry once again has his finger on the key stock market issue.  (And congratulations on the recogition by a major trading publication.)  Why have we had several years of excellent economic growth accompanied by reduced budget deficit projections, stellar corporate profits, and vastly improved corporate balance sheets without a concomittant increase in stock prices?

His answer, unfortunately, is a tautology.  We have had multiple compression.  The PE multiple accorded to the market is lower because — well — because we are in a "cycle" of lower multiples.  This is not an explanation.  Take a look at Barry’s provocative post and the comments, particularly considering the views of the anonymous "ss."

Link: Not Expensive vs cheap.

This quote is typical of sell side rationalization: “One of the things that makes this market confusing is that some valuation gauges clearly indicate this market is cheap. James Paulsen, chief investment strategist at Wells Capital Management, recently …

To say that PE multiples are lower is not an explanation, nor does saying that the pendulum is swinging to lower multiples help us understand the issue.

The idea behind the "rule of 20" is that PE multiples should be related to something.  In this case, the something is inflation.  At least that makes some sense.  If inflation is higher, your earnings return from stocks should be higher.  The PE is compared to some economic feature, not considered in isolation.

Other comparisons would be to look at forward earnings compared to bonds or real estate or gold or — well anything!  Talking about multiple compression in a vacuum does not inform us.

Has anyone else noticed all of the ads for gold on TV?  I had a recent consultation from a friend of a friend about an "investment" in pre-1933 gold that they heard about on the radio.

It all comes back to comparing the prospective return from various asset classes.

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