Investing: High Price Ratios and Cheap Stocks?

by | Oct 3, 2002

At the top of the late great bull market in 2000 investors kept coming up with reasons why stocks weren’t really overpriced. I came up with a few juicy theories myself that will live forever in the Rationalizations Hall of Fame. But now, in the bowels of the longest and deepest bear market in the […]

At the top of the late great bull market in 2000 investors kept coming up with reasons why stocks weren’t really overpriced. I came up with a few juicy theories myself that will live forever in the Rationalizations Hall of Fame. But now, in the bowels of the longest and deepest bear market in the post-war era, investors are just as eagerly thinking of reasons why stocks aren’t really underpriced.

I can think of plenty of reasons myself — there’s no shortage of things to worry about in the world today. But at the same time, I’ve written here repeatedly that, according to my “yield gap” equity valuation model, stocks are as cheap today as they’ve been at any time in the last 18-1/2 years — the entire history of the model. Right now we are experiencing a steady earnings recovery everywhere in the economy but the technology and telecom sectors, so the earnings yield of stocks is way up. At the same time, long-term bond yields are at 35-year lows. So according to the yield gap model that compares earnings yield to bond yield, stocks are a bargain.

But right now nobody is interested in bargains (which is why the bargains are there in the first place, of course). Everybody is interested in rationalizing why stocks aren’t really as cheap as they look. For example, one hedge fund manager posted this question on Trend Macro Live!:

Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at www.poorandstupid.com. He is also a contributing writer to SmartMoney.com.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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