Arguments For Shiller P.E.

Good discussion. let's start with James' main point. We are not in an equity bubble although it is building.
'Bubble' is an unfortunate word. It presumes that asset prices will collapse. But, can't we have bubbles that deflate gradually !here is one clear bubble in our economy "and Japan's#, and that is the assets that our $ed has on the boo%s, with the concomitant, huge, e&cess ban% reserves. I can't imagine that bubble 'bursting', but if it did, equity prices would collapse' not necessarily because they were in a bubble, but because of the other bubble. (o, let's rephrase the question to) are stoc%s overvalued to an e&traordinary degree, such that a crash is impending *o. (o I'm in agreement with James there "i own long+term puts though#, but not for the reasons he gives. ,nnual -./ based on future earnings estimates or trailing earnings are a pretty useless valuation measure because both denominator and numerator are so volatile over the space of a year or so. !his is corrected by (hiller's 0,-/, which is also a worthless timing short+term timing indicator, but a very good long+term total return indicator. (hiller "and James (tac% of Investech# recogni1ed an equity bubble in late 2334, when equity valuations hit 2353 levels, but of course that bubble inflated enormously for 67 years more. -eople rarely mention /asterling of 0restmont 8esearch, but I thin% he has much to contribute toward using normali1ed earnings as a valuation and timing metric. 9e has a scatter diagram that shows that normali1ed "and annual# -/'s have been very dependent on inflation rates. !hey tend to be low when inflation rates "0-I# are less than 2: "i.e. bordering on deflation# or more than ;:. (o in 2353 there was no consumer price inflation "because of those wonderful technological innovations that lowered production costs and increased corporate profits #, and elevated -/'s came crashing down. In 2344, normali1ed -/'s were pretty high, and inflation brought them down. In 2334 + 5<<< inflation was in the sweet spot, and so the mar%et didn't fade.collapse, until it basically fell from its own weight " + because we don't really %now. rising short+term interest rates and decreasing liquidity were a factor.# In 5<<= + we %now what happened there + house price bubble, debt bubble, and liquidity crunch etc. (o here we are in the sweet spot of inflation again, and -/'s could e&pand much more. Watch for a further contraction of 0-I from its current 2.5: yoy level though, because the mar%et will probably want to buy other assets if inflation continues to recede despite all this liquidity. 8e+ profit margins and corporate profits as a :age of G>-. I accepted 9ussman's argument that they must come down, and you haven't really persuaded me otherwise James. I don't %now what role foreign earnings are playing in these high margins, but we do %now that foreign earnings are staying overseas, and ,pple "one e&ample# is borrowing to buy bac% shares because it doesn't want to repatriate those earnings. "9ow much are they ma%ing on those retained earnings overseas btw # ,s someone else pointed out, competition in a capitalist society should lower those margins, and I would add that if the margins are being made because labor is not being rewarded to the full e&tent of its productivity, then that reduces aggregate demand for products and services. /ven if the profit margins stay at these levels further gains in corporate profits must come from increased revenues, i.e. from economic growth, which is dependent on growth of the wor% force and the productivity of that wor% force, and from inflation "because corporate profits and profit growth are reported as nominal entities#. /conomic growth is highly unli%ely to be sustained at a rate greater than 5: in the ?( and /urope, and we don't %now about inflation, e&cept that both high inflation and deflation are bad for stoc%s. If profit margins can be sustained at these levels, btw, wouldn't that mean that we are in a new era @h dang, that's a sign of a bubble. I too have noticed the stoc% prices of some corporations going nutty. @ne that few people mention is 0AG "0hipotle#. But as I recall, the (B- didn't start falling until about 4 months after the *asdaq pea%ed. (till, several of these high fliers going down is probably a good sign that the rest of the mar%et will pea% shortly. $inally, you don't need a blac% swan to bring this mar%et down. !here was no blac% swan in 2353, 5<<<, 5<<=, 23C=. Aany people saw the rise in ris%. ,nd you don't need a bubble to burst to bring stoc%s down a lot. I'm short+term long, and hedged long+term. ,s stoc%s rise through -/ multiple e&pansion the ris%s of a mar%et brea% increase, and the mar%et brea% may ensue from a change in the inflation picture, a decrease in $ed provided liquidity, or sovereign bond default by any one of a number of countries.

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Good discussion. let's start with James' main point. We are not in an equity bubble although it is building.

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