The Stock Market and Interest Rates
The quick and dirty rule of thumb is that the relationship between bond yields and the S&P 500 PE is one-to-one.
That is, 100 basis point change in bond yields should cause about a 100 basis point change in the PE.
Since WWII, the long term trend for earnings growth has been some 7%, or about the same as nominal GDP growth. I’ve long thought that the PE is an expression of the present value of a perpetual stream of 7% earnings growth
In the 1990s bubble , investors came to believe that long term earnings growth had moved to a permanently higher level and that justified the higher valuation.
Now, I wonder if the market, in its wisdom is already discounting a lower level of earnings growth, maybe about 4%. That could explain why the market looks cheap. Interestingly, in this recovery nominal GDP growth has been very stable around 4%.
Well, I’ve been wondering: With the financial sector making up a much larger portion of GDP, coupled with overstated asset values, what, if any impact this is having on the overall market? I heard Felix Salmon on the NYC public radio this morning talking about all the “printing” of money by the Fed, and market participants reaction to yesterdays statements by Bernanke. Is the Fed really printing money, or just adding liquidity to stabilize overstated balance sheets of financials? Obviously, I’m confused. Right?
My opinion–take it for what you think its’ worth –is that Fed policy, as is the case in Japan, is able to keep the market and economy from collapsing but is not able to generate strong self-sustained growth.
The risk is that if and when the Fed withdraws QE is that the market and the economy will swoon.
Spencer
that 4% is “nominal”?
i see that’s what you said about GDP. just wanted to make sure that’s what you meant about earnings growth.
Over the last ten years — what is used in the Schiller PE — earnings growth is 4%.
Both nominal GDP and earnings varied a lot, but the long term trend from WW II to the great recession was about 7%.
Both are now b
got cut off.
Both are now below their 7% trends.
The economy isn’t struggling anymore. Nice production surge in May/June. May be the final path toward full recovery.
IMO, steady nominal growth and falling inflation are a good thing, thus earnings not be needed so high.
Nanute, the liquidity needed to “bail” out the financial system was done during the bailout.
There is no money printing. There has been “some” liquidity in the system to help spur debt reduction, but that itself has been modest and mortgage debt is getting close to historical norms.
Internet econ blogging has become far to intellectualized and not enough actual studies into how markets work and what is pushing the those markets in that work.
The Austrian and Post-Keynesian schools are the worst. Neither have a slightest clue what is going on right now. They are spewing intellectualized jargon that does not match the market, thus I see some reputations being destroyed over the next 18 months. Whether that turns into physical violence by some of its followers on these “economists” remains to be seen. Betrayal is usually does not end well.