I agree, Jacob. I think too many investors, bears most notably, take one statistic and say over and over the market is overvalued. But you should never do that. You have to look at the big picture. For instance, taking a page out of Greenspans very enlightened notebook, PE is a red herring. Sure the S&P500 composite PE is at historical highs and has been for a long time now. Does that mean the S&P 500 is overvalued and will correct over the next decade so that investors only should expect an average annualized return of 5%?
NO! That's a resounding NO!. The reason is this. If you look at other statistics, most importantly productivity, then high PEs become justifiable. Greenspan's logic, which is extraordinarily compelling, is that higher productivity allows the economy to expand at faster rates for longer periods of time, while keeping inflation in check. The reason for this is simple. If I am able to produce $5 of value this year for my company, and then due to technological advances I'm able to produce $10 of value next year, then my productivity has increased and my company becomes more profitable by doing more with less or doing much more with more. So the market digests this information and prices stocks according to new higher expectations of future growth rates, which inflates PEs to higher rates than the historical mean.
Now take that logic and apply the fact that technological advances are actually accelerating across the globe. For proof of this look at the macro. There has been more technological advances in the last 50 years than in the previous 10 centuries. That rate of change is increasing. This means that by the very nature of humans building knowledge on the building blocks of prior knowledge, we can expect productivity per headcount to increase steadily over time ad infinitum (at least until human creativity becomes non-existant). If productivity can be expected to increase steadily ad infinitum, then you will see composite index PEs also steadily increase over the long term, which will also pull up those historical means. So instead of the common thinking that everything regresses to the mean, we have here a situation where the rate very well may regress in the short term, but over the long term, the mean will increase. Thus, we can expect that higher composite index PEs are here to stay, barring cataclysmic events that serve to pull down the technological level of the entire global simultaneously (read global nuclear war).
In summary, I believe higher index PEs are here to stay. |
