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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory
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To: ild who wrote (64592)6/26/2006 5:21:37 PM
From: benwood  Read Replies (1) of 110194
 
If you look at the DOW in the last big expansion from 1982 to 2000 or so, the index increased from about 800 to 11,900, or roughly 15x. The expansion of the P/E was from about 8 to about 44 during that span, or about 5.5x. That means that for the moving-target (survivor bias) index, the gain from earnings would be 15/5.5 = 2.7x. So the gain from the expansion of P/E from 1982 to 2000 was roughly double the gain from earnings increases, not including any consideration for growing companies being swapped into the index.

Conversely, earnings expanded about 2.3x (if my rough calculations are correct) from ~1965 to ~1982 yet the P/E decline significantly from about 23 to about 8. So that down cycle saw almost the same overall earnings growth of the index stocks (again a moving target), yet with the P/E collapse the index actually declined.

If my math is correct, then the '82-'00 period was only about 16% better for earnings growth than the '65-'82 period, yet the index increased 1500% rather than decreased 20%. This ignores dividends but the overall difference between the two periods would not be that great esp. compared to the index valuations themselves.

Based on that, it does seem like the P/E expansion/contraction is by far the biggest driver.

Currently, we are still something like 1.5x the long term mean.
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