Monday, June 09, 2003

Everybody is gittin jiggy wid the stock market again these days. The S&P500 is flirting with 1000 again, the first time since June 2002, and all the young bucks on Wall Street are starting to feel their antlers once again. But is this based on surging testosterone or something a bit less ephemeral?

The markets are still exceptionally expensive -- with all this money sloshing about the world thanks to loose monetary policy, folks want to invest it (shoving it inside your mattress just seems so Beverly Hillbillies after all) regardless of whether there are any good investments out there or not. Money Magazine tells us the price-to-earnings ratio of the S&P500 now stands at 31.4. Now that's down from the stratospheric days of 2000, but still, before 1998 it had never been above 30. You don't like this measurement? How about the Shiller method?
A way of valuing the market, made popular by Yale professor Robert Shiller, is to look at price compared with average annual earnings over the past 10 years. On this basis, points out AQR Capital Management managing principal Cliff Asness, the S&P's P/E comes in at just under 25. Historically, that P/E has come in at around 14 or 15. Asness thinks that historically stocks have been cheap and that, if investors can accept a lower return environment than they've had in the past, the market can trade at a Shiller P/E of around 21 or 22. As a result, he thinks the market is 10-to-15 percent higher than it should be.

He also notes that, because he is using a P/E implicitly based on trend earnings, the idea that stocks should have a high P/E now because earnings are going to be higher in the future doesn't fly. In fact, he said, if earnings don't recover, things could be "fairly ugly."
Just when you thought the US was safe from irrational exuberance, here come those giddy feelings back with a vengeance. Be on the look out for secretive late-night phonecalls, mood swings, furtive notes passed in study hall, the "I really like you as a friend" speech, incessant crying and broken hearts -- just ahead!

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