Comments on: Chart of the Day: The stock market’s P/E Ratio A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: anon Sat, 22 Aug 2009 19:37:31 +0000 I was reading everyone’s posts, and would like some feedback. Forgive me if my question is rudimentary, as I’m not an economist nor particularly knowledgeable about economics.

Here’s my question: hasn’t the stock market been experiencing a bubble in the making for the past 20+ years as a result of the baby boomers saving for retirement? If you look at the history of the p/e ratio, you will see it began to spike around the same time boomers probably started saving for retirement. It has been growing rapidly ever since until the latest crash of course. Now, what happens when all the boomers stop contributing to the stock market and at best start living off their investments, or at worst start drawing down on their investments? Won’t that result in the p/e ratios closer to their historical levels?

I also noticed that the p/e ratio started to climb drastically at the same time the 401K program was instituted. In other words, the boomers started to plow their own moneies into the stock market at that time.

The question someone raised earlier about looking at the bond market seems valuable to understand how the allocation between bonds and stocks changed as a result of individual investors making their own decisions about investment strategies.

Does anyone have any insights into these issues?


By: stock trader Mon, 17 Aug 2009 18:20:15 +0000 Will the profits outperform GDP? yes, as eu correctly said GDP is real, whereas profits are nominal, besides that you have to remember that some companies will go out of business and thus competitors will take extra profits.
It’s impossible to answer to a particular company as it depends on the management, future potential and events and stock markets are unpredictable.

By: eu Mon, 17 Aug 2009 17:35:54 +0000 >Does anybody really still think that corporate profits are going to be able to rise faster than US GDP indefinitely?

Yes, they have to, since GDP growth is measured in real terms (without inflation).

Your point should be that corporate profits will grow as fast as “nominal GDP” or something like that.

By: Ken Mon, 17 Aug 2009 15:16:56 +0000 I actually disagree with Henri.

Despite EMH doctrine, I think that there is more in a share price than a cold present value calculation. It would be nice if it were that simple.

A P/E ratio at its simplest is a measure of how much one is willing to pay per dollar of earnings. There are two basic elements at work here, the price at which the equities are trading and the level of reported earnings per share. It is easy to see how the concurrent behavior of the variables relates to the subsequent volatility of the ratio.

Statistically significant swings in the ratio need to be understood from the standpoint, first, of the motions of the underlying components. At that point, utilizing the contextual variables Henri mentions, the trading and psychological distortions of the market can become more clear.

From my perspective, to utilize Henri’s basis for share price calculation, shares are overvalued based on conditions and expectations – but that is the problem – he may disagree on the baseline assumptions of those values and will come up with markedly different results. Nevertheless, the end result is a historic record of what the market as a whole is willing to spend per dollar of earnings, whatever their individual assumptions may be, at a given point in time.

In deference, I think Henri would be right, if he were talking about the analysis of a specific equity. However, we are talking about measurement of a pricing indicator of a market index, hoping to gain an understanding of the combined implications of all our discrete pricing decisions. It is a contextual measurement that may add some color to the big picture – highlighting distortion, irrationality, excessive pessimism, or excessive optimism.

Are our calculations having us spend too much or too little for each dollar of earning? Are our assumptions overly optimistic? Are people behaving irrationally? These are all questions that the measure can color, not answer. But they are important ones to consider, despite being heuristics at best.

This is where EMH and quantitative finance fails. Investors are irrational and so we need more than a mantra to navigate the topology of complex human interactions.

Nevertheless, I would be interested in seeing how Henri utilizes actual interest rates and expected inflation rates to justify such a significant spike in the ratio. Or is it based principally on anticipated future earnings? And isn’t that what a bubble is built on? The promise of future earnings?

By: Henri Tournyol du Clos Mon, 17 Aug 2009 04:10:21 +0000 Come on, Felix, you should know better than comparing P/E ratios at different points in time. There is some very basic concept in finance called present value, you know (although quite a few people in the economics profession, including, sadly, Paul Krugman – cf  /08/permanently-high-home-prices/ – have never managed to grasp what it actually means ) and shares are just the present value of expected future cash flows discounted with a set of real interest rates. So you have three different sources of P/E variations :
1 – expected nominal profit growth rates; and, yes, they should be larger than nominal GDP growth rates, because GDP includes a lot of not-for-profit & unlisted activities.
2 – actual interest rates;
3 – expected future inflation rates.
P/E ratios are a rudimentary but effective tool for comparing shares at the same point in time, full stop. Interest rates and inflation expectations (though these are really tricky to assess)have changed quite a lot since 2007, let alone 2002.


By: Adam Mon, 17 Aug 2009 02:29:06 +0000 Where do those P/E #s come from? They don’t represent the true reported S&P 500 earnings, from what I’ve seen. They seem to be based on “operating earnings”, which exclude “non-recurring” losses. That’s a problem when those losses are huge and have a real impact on businesses, and when they happen every quarter. Conversely, non-recurring gains are sometimes included in “headline earnings” numbers.

I did a post a few weeks ago about these types of manipulation. Feedback welcome:

By: Miles Mon, 17 Aug 2009 01:25:27 +0000 I think it’s more that this chart shows how forward P/E expectations are more relevant than current P/E, which seems entirely reasonable. If you happen to make another chart, I think it would also help to see bond yields as well, since people have savings they need to put *somewhere* and that’s the main alternative to equities.