Stocks - the Valuation Question Revisited
As always happens after stocks have had a nice run-up, bulls suddenly emerge from the woodwork everywhere to tell us why there has never been a better time to buy stocks. One of those is Jeremy Siegel, the notable perma-bull from Wharton, who now argues that the DJIA could easily hit 15,000 points 'in a few years'. This is an uncharacteristically modest target for Siegel, but we are more interested in his arguments than his targets. Among those we find the old standby that 'stocks are cheap'. However, this argument glosses over the historical record of secular bear market periods. Stock multiples as a rule do not just 'return to the mean'. They tend to return to the other extreme, i.e. from extreme overvaluation to extreme undervaluation. Of course the experiences of the past do not guarantee the outcomes of the future, but there are a number of good arguments in favor of a repeat of the usual secular cycle. With regards to the valuation question (Siegel curiously also thinks dividend yields are a good argument for buying stocks here, but again, the historical evidence says otherwise), the closer one looks at it, the more dubious the argument becomes.
Specifically one should not rely on the 'Fed model' or similar comparisons of stocks to bonds. These are highly misleading in a debt-deflationary secular downturn. A good friend of ours has prepared two charts that show that on a smoothed three-year basis (a compressed version of the Shiller p/e), the price/earnings multiple of the S&P 500 is anything but historically cheap. In fact, it now as expensive as it was in 1929 or 1966. Neither was a particularly propitious point in time to buy stocks. While the economy has lately improved, we remain very skeptical due to the imbalances in the capital structure that have once again become evident. A 'recovery' based on the fumes of monetary pumping should always be highly suspect.
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