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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: porcupine --''''> who wrote (590)	8/5/1998 4:22:00 PM
From: porcupine --''''>	Read Replies (2) \| Respond to of 1722

High US P/E ratio risky late in cycle-St Louis Fed By Isabelle Clary NEW YORK, July 29 (Reuters) - U.S. price-to-earnings (P/E) ratios, which have surged late in an expansion despite little prospect of higher corporate profits, may spell greater risk than investors believe, a Federal Reserve Bank of St. Louis senior economist said on Wednesday. ''When people want to try to convince us stocks are not that expensive, they say the P/E ratio has been high before,'' St. Louis Fed senior economist Bill Emmons told Reuters. ''But that's not quite true. P/E ratios reached in 1997 and 1998 are without historical precedents for a mature expansion,'' said Emmons, who noted the P/E ratio for the Standard & Poor's composite stock index averaged 28.04 in June -- a record for the series dating back to 1871. ''At the current level of stock prices, a decline in corporate earnings of 30 percent would cause the market P/E ratio to soar to about 40, a level never before seen in the U.S. stock market,'' Emmons said. He noted such valuation was reached by Japan's Nikkei index near its top around 36,000. Emmons, who wrote about stock valuation in a recent issue of the St. Louis Fed's ''Monetary Trends,'' pointed out that high P/E ratios prior to 1997 occurred in ''either recession years or soon after the end of a recession.'' The S&P P/E was above 26 near the end of a deep recession in 1893-94 and in the midst of the 1929-1933 Great Depression, while all P/E ratios above 20 occurred during or just after a recession -- ''with the exception of 1998,'' he said. The early stage of a recovery implies strong rebounds from low levels of economic activity, and thus strong prospects for higher corporate earnings. ''You could make the case today's very high P/E ratios make some sense if we were on verge of huge rebounding profits,'' the St. Louis Fed economist said. ''But we are at the end of a very strong period of corporate profits and you have to ask where profits will be over the next couple of years. At some point, you start discounting the thereafter,'' added Emmons, echoing Fed Chairman Alan Greenspan's recent words of caution about stock valuation. U.S. corporations made the most of the rapid expansion, which clocked in at a nearly 4.0-percent annual pace in the nine quarters through March 1998, by containing costs, improving productivity and boosting profitability. ''Companies have already accomplished huge efficiencies. It's hard to figure how they could accomplish huge profit growth from here, without mentioning the negative effect from Asia, a very strong dollar and tight fiscal policy,'' Emmons added. ''None of these things would make you think we are on the verge of a profit explosion.'' Emmons added he was aware of the ''baby-boomers' capital flows'' argument that says retirement funds pouring into the stock market have made the notion of valuation obsolete. But Emmons pointed out that demographic fundamentals hurt long-term stock prospects since baby-boomers who are all pouring money into the stock market today would seek to withdraw it at the same time later. ''There are demographic problems coming down the road. We know these mutual funds will slow down and reverse,'' added Emmons, who co-authored a soon-to-be-published research paper on social security funding. Minutes of recent Federal Open Market Committee (FOMC) meetings showed pricey U.S. financial assets were discussed by policymakers because they can either contribute to growth by creating a ''wealth effect'' through their appreciation or depress consumer sentiment and spending in the event of a correction. St. Louis Fed President William Poole dissented at the May FOMC meeting, asking for tighter policy in response to rapid money growth.