Tuesday, September 02, 2008

U.S. Stock Valuations Reach New Highs

Bloomberg today reports that the price to earnings ratios of U.S. stocks has risen to more than 25, the highest level since 2001.

Clearly this is far too high, so it is clear that investors are pricing in a sharp rebound in earnings. But the only way that can happen is if the downturn ends soon, which I find unlikely. Meaning that U.S. stocks are overvalued from a fundamental point of view, both compared to the past and compared to other stock markets. A important reason for this is that U.S. interest rates are so low compared to both the past and compared to other countries, meaning that investors who want to hold dollar assets see few alternatives to stocks.


Blogger Aragon said...

Another interesting thing happened in the American stock market some weeks ago: the S&P 500 index gave absolutely zero real returns for the latest ten years, even when dividends are counted.

The P/E-ratio of 25 doesn't sound good for the American stocks. In fact, it is extremely rare situations that this high P/E-ratios have given equity investors returns at all in the near future. And usually when P/E-ratios begin their long term decline they drop gradually all the way down to even below 10.

Robert J. Shiller's explains this phenomenom in his valuable book Irrational Exuberance (2005 edition), pp. 208-209 quite well:

When prices stop increasing for a long while, there is a gradually increasing discontent with this view... This... may cause stagnant or declining markets even when fundamentals are increasing... This [stagnation in stock prices] can happen as part of a negative feedback loop, as part of a gradual response to poor returns on stock gradually reduces investor demand for stocks and hence reduces their prices relative to fundamentals. People may gradually get increasingly "fed up" with stocks.

What is your take on this scenario? Shiller has been a pretty good when predicting what future holds. Unfortunately as a non-Austrian he pays hardly any interest to the role of the Federal Reserve in asset bubbles.

7:59 PM  

Post a Comment

<< Home