På börsen har det rullande p/e-talet för de kommande 12 månaderna kommit ned till 12,1
Equities look overvalued, but where is the turning point?
Some analysts are prepared not only to explain day-to-day movements in markets, but to predict them. I am neither clever enough for the former, nor rash enough for the latter. I am prepared, however, to make four statements:
Any long period of market stability encourages speculation. Taken to excess, such risk-taking, particularly when fuelled by huge amounts of borrowing, can create significant instability.
The chart, taken from data prepared by London-based Smithers & Co, shows the actual and the cyclically adjusted price-earnings ratio of the Standard & Poor’s composite index since 1881. The cyclically adjusted measure follows the method of Professor Robert Shiller of Yale university: it is the ratio of stock prices to the moving average of the previous 10 years’ earnings, deflated by the consumer price index.
The picture shows that the actual p/e ratio is now very close to its long-run mean of just over 15.
What is going on? The answer is that the US – and, indeed, most of the world – has experienced an enormous surge in corporate earnings.
It is always a mistake to confuse a cycle with a trend. In the case of corporate earnings, it is worse than a mistake, it is a huge blunder.
If we are to assess when that might happen, we have to recognise that the buoyancy of corporate profitability is just one of several extraordinary features of the world economy. Here are a few others:
Some of what we see is also surprising. This is particularly true of the association of rapid global economic growth and high profitability with low real interest rates and little concern about inflation. A world such as this is one in which one would have expected high real interest rates and worries about inflation, not the opposite.
But the biggest risk is that the end of the US property boom will persuade US households to tighten their belts at last, thereby ending the US role as the world’s big spender before the big savers are prepared to spend in turn.
If the stock market were to drop 20%, then the P/E ratio gets to 12, assuming earnings don't fall.