In yesterday’s reads, I mentioned a The New Yorker article on Paul Krugman. One line in the piece jumped out at me:

“Let’s put it this way. I can have fairly high confidence—it’s a personality thing—that a market is overvalued. Somehow I never have the same confidence in saying that it’s undervalued.”

Hey Paul, the reason for that has nothing to do with your personality — rather, it has to do with who was running the Fed for most of your adult life: Some guy named Alan Greenspan.

Consider the following two charts:  The first chart shows the 1977-2007 period P/E ratio for the S&P500, highlighting the band of where stock prices would have been if the P/E ratio had stayed within one standard deviation of their long term average.

As you can see, for most of Greenspan’s tenure, as well as Bernanke’s (excepting the March ’09 lows), stocks have been mostly-to-extremely overvalued:


Source: S&P, Factset


The second chart is a chart of how much the consumer leveraged themselves up during Greenspan’s tenure: What they purchased in excess of their cash income:


It appears that a leveraged consumer and a pricey stock market were the most likely culprits — not your personality.

Perhaps a better title for this post might be “When Were Stocks Last Fairly Valued ?


See also:
Are Earnings Normalizing? At What Level? (February 22nd, 2010)

Category: Investing, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

60 Responses to “When Were Stocks Last Under Valued ?”

  1. I cannot find a source for that second chart — anyone recognize where its from?

  2. Patrick Neid says:

    I don’t know what entry they are talking about for Alan but the grand one was back in 1987 just in time for the crash.

  3. Mannwich says:

    Wow, is there anything more that needs to be said?

  4. cognos says:

    So stocks should be paying 6% cash dividends… that makes ALOT of sense.

    This is the mirror image of DOW 36,000… just as stupid.

  5. bsneath says:

    It was fun while it lasted.

  6. How do you reach the conclusion that a 6% div yield is appropriate ?

    “As the algebra teachers used to say “Please show your work”)

  7. Ghost in the Machine says:

    Don’t get bent out of shape over the Cogman — he tends to draw unsupported conclusions, then blames you for leading him to a ridiculous place.

  8. Even on a CAPE/PE10-basis, the over-valuation of the S&P (vs. historical, at least) has been around for the last 20 years ( That said, it’s existence for that long should be pretty good evidence that irrationality can last longer than solvency!

  9. I have a big CAPE post coming up this week — some great stuff in it

  10. cognos says:

    BR – Those charts imply that 550 SPX is “fair”, right? Didnt S&P pay $25 in divs last year? Will pay even more this year, and next. It’s silly.

    Those charts imply S&P was overvalued in 1993-4 despite returning 7.5% annually since then… half of which (~3.75% annual) was in cash divs. Had we tracked the “avg PE” line… I submit divs would’ve added 5-7% annual return.’

    People forget… these same arguments were around in 1985… (S&P overvalued at 155!).


    BR: I’m looking at Earnings as a measure of vaulation — not dividends

  11. KidDynamite says:

    that second chart is amazing. really the visual definition of “unsustainable” in reference to our spend-to-paper-wealth habits.

  12. Marcus Aurelius says:

    Are stocks overvalued? Hell no! Buy now, or be priced out forever!

    If the CEO is overpaid and selling shares, the stock is probably overvalued. Nowadays, all of the CEOs are overpaid and a buttload of them have been selling stock.

  13. Myr says:

    But you expect this bear market to look like ’73 – ’74? The problem with that view is that stocks never got ridiculously expensive back then as they did this time around. They also didn’t have the absurd debt problem we have now. Context is everything.


    : We already looked like 73-74-75: Down 50% up 70% — the next move according to that analogy would be down ~25%

  14. Marcus Aurelius says:

    To answer the question: according to the first chart, the last time stocks would have been undervalued would have been 1982 – 1983, as any price within or above the STD P/E is bubble territory.

  15. The Curmudgeon says:

    So, outside of overleveraged consumers, why did the PE’s shoot higher, and more volatile, over the last twenty years? The advent of technologies that allowed for more potential participants and thereby more liquid markets? I think some consideration has to be given to the information and communication technology that makes owning stock no different really than having cash in a bank account, well, except that you can lose everything in the market, and with bank accounts you generally don’t. Of course, because of that, neither can you make any money.

    So, there it is: PE’s arced higher because of the FDIC guarantee on bank accounts. That’s tongue in cheek, of course, but such a gigantic government amelioration of risk is apt to have profound effects in ways we can only imagine. Yet it is hard to believe that stocks are “overvalued” based on some historical average, especially when it appears they’re starting their third decade “overvalued”. Something else is afoot.

  16. mysterious eggs says:

    @The Curmudgeon “Something else is afoot.”

    It’s worth looking into. Maybe we have a finite risk system. Risk cannot be created nor destroyed, only passed to the next sucker. Government support for deposits and glass steagall being repealed results in the government assuming a lot of risk. Government supporting failed banks with the addition of no reform results in tax payers assuming most of the risk. Tax payers supporting failed government results in what? That’s tongue in cheek, of course, but such a gigantic taxpayer amelioration of risk is apt to have profound effects in ways we can only imagine.

  17. constantnormal says:

    The second chart kinda-sorta makes sense, in an environment of most interest rates being abnormally low (where “abnormally low” means lower than necessary for business to function at nominal levels). When you are in a permanently-low rate environment, everyone eventually gets bitten by the leverage bug, and borrowing becomes the “new normal”.

    But with Bernanke apparently subscribing to the same methodology as Greenspan, can we expect anything different going forward?

    I know that just as soon as the dust settles, I’m gonna leverage up again … :-)

  18. Mannwich says:

    The new “Bagholder Economy”. Catch the fever.

  19. constantnormal says:

    @mysterious eggs — “a finite risk system” I like it. You should patent/copyright that, or at least write a chapter in some economics textbook promoting this notion. You can title it: “All you can lose is all that you’ve got”. And with such a notion, the excess risk accommodated by massive amounts of leverage merely slides on to the next sucker in the chain, ultimately to the taxpayer.

    And when the taxpayers’ ability to pay for negative credit (i.e., imploded risk/bad debt) is exceeded, the remainder spills over onto the the global markets, with their risk assigned appropriately.

    You could have a new school of economics here — centered around the “Conservation of Risk”. Some historical data wrapped in a bunch of theorems could earn some aspiring grad student a shiny new PhD.

  20. constantnormal says:

    When we bought our house back in the last millennium, the developer’s tagline was “All the land that ever was is all there’s going to be” (or words to that effect). In a finite risk system, you could use a similar tagline to sell CDOs, ETFs and just about any old securitized thing … “All the risk there ever was is all there’s ever gonna be — step up and embrace your risk today!”

    The Securities may not be suitable investments for all investors, and the Securities are intended for purchase only by investors capable of understanding the risks involved in such an investment. No investor should purchase any of the Securities unless such investor understands and is able to bear the price, yield, market, liquidity, structure, redemption and other risks associated with that Security. Investors should consult their own Ñnancial and legal advisors about the risks arising from an investment in a particular issue of Securities, the appropriate tools to analyze that investment, and the suitability of that investment in each investor’s particular circumstances. See “Certain Investments Considerations” beginning on page 13 for a discussion of certain risks that should be considered in connection with an investment in the Securities.

  21. douglasbtrain says:

    “Something else is afoot.”

    The 401k is afoot. Isn’t all this related to all of us “investing” part of every paycheck regardless of the opportunities available? There is an entire industry based upon telling us to buy mutual fund shares with every paycheck. No matter what. And to never stop buying and never time the market.

    The consumer debt chart goes up for the same reason. People can’t pay off the credit card because they are contributing to a “retirement plan”.

    The same thing happened to the government (at least partially) because of all those deferred taxes.

    I can only imagine if people had paid their taxes and bought CDs or stuffed the money in their mattresses or paid their credit card bills how all these charts would look.

    Someone please tell me if I am wrong or crazy. By the way, isn’t it anti-market to have people putting money into the market every month regardless of the opportunities? Isn’t that the opposite of investing?

  22. constantnormal says:

    …pity … the [small] html tag didn’t work …

  23. constantnormal says:

    @Mannwich 2:22pm

    What do you mean new “Bagholder Economy”?

    Ever read about the bucket shops in the 20s? Or John Law? The Madness of Crowds has always been with us — I think it must be part of our genome. There must be some aspect of buying a pile of manure so we can dig for the pony inside that makes it advantageous — in a Darwinian sort of way — to the species as a whole.

  24. karen says:

    Great post, BR, keeping is simple.. and those charts are worth a thousand words : )

  25. Mannwich says:

    @constantnormal: Not really new per se but more pronounced, IMO, and more obvious.

  26. Mannwich says:

    …….and pervasive, if you will.

  27. ashpelham2 says:

    Stock price increases were driven by the same dynamic that drove them high in the 1920′s. It was overrational exuberance, and that’s all that can be said. We had a time of relative peace in the late 80′s through mid 00′s, with only a few short, isolated US conflicts we were involved in. No big wars. Innovation was at a high, in the 20′s it was toasters and washing machines, in the 1990′s it was technology and all it promised, and in the 00′s, it was government and banks conspiring to keep the party going with creative financing.

    This recession should have begun in late 00, early 01, then fell off the cliff after the 9/11 attacks, and then started to heal in 03. We allowed ourselves to pulled into the buy, buy, buy for America’s sake rhetoric.

    Now, we’ve bought all we need to. And the nail in our coffin right now is that we’ve priced ourselves out of jobs.

  28. Mannwich says:

    @ash: But at least we can all be rich flipping overpriced pieces of paper to each other. Much easier and “more liquid” than doing the same with tangible assets like homes.

  29. nofoulsontheplayground says:


    The last chart shows Greenspan starting in 1991, but I believe he started in August 1987.

    That little red “x” needs to be moved over a section to the left on that chart.

    What’s interesting is the red “x” as it is placed now is close to the 1992 time frame when the Credit Default Swap was conceived.



    BR: Good catch — you are right . . .

  30. The Curmudgeon says:

    “— I think it must be part of our genome. There must be some aspect of buying a pile of manure so we can dig for the pony inside that makes it advantageous — in a Darwinian sort of way — to the species as a whole.”

    I think what’s in our genome is the herding instinct. Buying piles of manure just because everyone else is buying pile of manure is just an effect of the instinct, which has survival advantages in some times, but not when the lemmings get too close to the cliff.

  31. hamstak says:


    You beat me to it. If you are wrong or crazy, so am I. From Wikipedia:

    In the mid-1980s, there were fewer than 8 million participants with less than $100 billion of assets in 401(k) plans.[5] By 2006, there were seventy-million participants with more than $3 trillion of assets in 401(k) plans.[5] There were 438,000 companies sponsoring 401(k) plans in 2003.[4]

    Another possible angle on this is that those who were contributing to 401k plans felt “wealthy” and “secure” and therefore were willing to assume debt believing that they would be able to meet those obligations well into the future based upon what seemed to be a perpetual rising securities market. Just a theory.

  32. torrie-amos says:

    well, the historical average of the plot of land i’m on is zero

    there are times when things do jump out of a standard deviation and forever form a new new normal

    i will say one thing, i got a hell of a lot more confidence in owning Nucor, than us gubment debt, and of course exxon

    of course they could go too zero like anything else, yet, when you look around and wonder what and who i have confidence in

    now who will have money to buy at xyz price, or even want too, ifin other stuff happens, that’s a different story

    peace in the 80′s and 90′s, afghan war by russia which bankrupted them because regan used the mullahs and the saudi’s to destroy them, remember ten dollar a barrell oil? that’s what bankrupted russia becuase it was there only income, u think saudi’s dumped the rpice for there health without some uhhhh favors………………that right there is a major part of osama’s hatred, us of a chose bankruptcy for russia while 6 million muslims died

  33. constantnormal says:

    @douglasbtrain 2:33pm

    “The 401k is afoot.”

    Sorry, but the data does not support that. The IRA programs began in 1974, with the 401K being introduced in 1980. The extension beyond the PE SD occurred around 1992. That’s too far for it to have been sparked by the continuous purchases of 401Ks and IRAs. Plus, as the 401Ks gained favor, corporations axed pension pan contributions at an even greater rate, negating any upward push from 401K investments.

    Good thought, tho’

    It appears that Greenspan’s ascendency is the best fit to the data. The Dynamite Prize was well-awarded.

  34. falcon says:

    Does anyone have a source for this? And can anyone tell me if cash income* includes employer 401k contributions? Someone is next to me is arguing that if this chart doesn’t include those contributions then that skews this number. Of course, I think that is wrong for many reasons. What exactly are “unspendable benefits?”

  35. Blissex says:

    Uh even more interesting, Ritholtz has forgotten the other crucial graph, one that he posted himself some time ago and that he occasionnaly updates, which tells a big part of the story:

    The intense attempts by the Fed and the administrations to keep stocks up by any means necessary began around 1985, but reached their peak in 1995, when a series so events (the yen ZIRP, the Contract On America Republican majority fueled by the votes of capital gains greedy middle class investors, removal of capital ratios and unregulation of finance) sharply ramped up all asset values.

  36. Blissex says:

    «The IRA programs began in 1974, with the 401K being introduced in 1980. The extension beyond the PE SD occurred around 1992. That’s too far for it to have been sparked by the continuous purchases of 401Ks and IRAs. Plus, as the 401Ks gained favor, corporations axed pension pan contributions at an even greater rate, negating any upward push from 401K investments.
    Good thought, tho’
    It appears that Greenspan’s ascendency is the best fit to the data.

    Well, the 401k were not solely responsible for the upward pressure on PEs; but surely they contributed over time, because in effect they were “sterilizing”, even if at a low rate, stocks, withdrawing them from circulation (“buy and hold”). And even the low rate can have an effect, because what matters to prices is the impact on *net purchases*. The existing quantity of buy-to-hold shares, for example the colossal amount held by entities with long term liabilities like pension funds, is not on the market, and that also greatly contributed to the continuous upwards pressure on stock prices.

    But the greatest contribution of the IRA/401k/… was psychological and political, as it transformed formerly progressive upper working and middle class into capital-gains greedy rentiers, “F*ck you! I got mine!” fanatics, looking forward to a luxurious retirement thanks to their surperior sagacity in investing into ever rising stocks (and real estate).

    Over again to Norquist to show that this was a well planned outcome:
    The 1930s rhetoric was bash business — only a handful of bankers thought that meant them. Now if you say we’re going to smash the big corporations, 60-plus percent of voters say “That’s my retirement you’re messing with. I don’t appreciate that”. And the Democrats have spent 50 years explaining that Republicans will pollute the earth and kill baby seals to get market caps higher. And in 2002, voters said, “We’re sorry about the seals and everything but we really got to get the stock market up.

  37. Blissex says:

    Closing bold and italic.

  38. David Merkel says:

    @cognos — the S&P 500 at present is throwing off only $22.43 of dividends according to my Bloomberg terminal. On a 550 S&P, that’s a 4.08% yield. That’s not unreasonable.

  39. lalaland says:

    Throw in the 2003 capital gains tax cut…

  40. cognos says:

    David Merkel — against a 0% Tbill yield? Against a 5-yr Tbond of 2.3%? If you looked historically at the ratio of divs to Treasury yields… wouldnt that be the highest multiple EVER? Has the div yield ever been 2x EITHER of these? Much less 10-25x bills and 2x 5-yr yield? That’s NON-SENSE.

    Why would “fair” be a 4% div yield (>8% cash flow… in the trough year!)?

    These charts flub the numbers to the downside. My bbg terminal shows TTM eps on SPX to be $58. At the +1 S.D. PE of 16.25x thats 948. Not 750?

    Uh, these charts show the S&P500 roughly 50% overvalued at 800 in 2003. Since 2003 the SPX has paid… $160 in divs. It currently has $200 in cash. That totals $360. Why was “fair value” in 2003 only $400? (Why do growth oriented equities need to “cash out” 100% in 6 years?… During the worst economic period in the last 30?)

    Investment “valuation” is always a matter of choices. You can buy stocks…. or real estate… or hold cash… or loan your money out on credit with bonds. You cannot say “they are ALL overvalued”. The future is always uncertain… its easy to be too conservative. Take no risk, and you will only lose through underperformance. But the long-term value destroyer is ever and always… being too conservative.

    Imagine if you held to gold in 1980. Or cash in 1985. Or in Feb/Mar 2009… very painful. Then you’re behind by 50-100%… what do you do then… cling to it? And claim the world is filled with inflation?

  41. SS says:

    @ Blisex

    Great comment, sir, one small correction, it’s not baby sales but foxes and minks that they bash; otherwise right on the mark.


  42. farmera1 says:

    “Ever read about the bucket shops in the 20s? Or John Law? The Madness of Crowds has always been with us — I think it must be part of our genome. There must be some aspect of buying a pile of manure so we can dig for the pony inside that makes it advantageous — in a Darwinian sort of way — to the species as a whole.”

    Well don’t forget Kondratiev, the dude Stalin shot for coming up with the wave cycles (sinusoidal-like) in capitalism. Every forty to sixty years capitalism goes through sine waves/nasty crashes. We’re due. Just thank Greenspan et al along with Goldman Sachs contributions for getting us an extra few years THIS TIME IS DIFFERENT might be real, as part of the great moderation.

  43. jabbo says:

    of course for the Greenspan Era to work first the US needed to close the gold window and free the USD from the monetary constraints of the “barbaric metal” … mmmm, wonder if the rating agencies would have considered this a “technical default”…

  44. wunsacon says:

    So true, Blissex.

  45. DiggidyDan says:

    PE’s don’t seem real in these charts. I have been following the CAPE with Robert Shiller’s data for several years running algos on it. As of December 09 (last time i updated it) the CAPE Mean was 16.35, the Median was 15.69 and the StDev was 6.59. Interestingly, when was playing with the historical data last year around July, a linear regression of the Natural Log of CAPE showed an upward sloping trendline. What does this mean? It means that CAPE has been increasing (with PE expansion) over 139 years of data. I would agree that this is probably due to external factors. I thought of survivorship bias as well as recent trends since 1982 of increased emphasis on stock ownership in retirement plans and increased access to stock ownership of the common man via mutual funds, 401k plans, and online and discount brokerages. Bottom line is, to infinity, this regression line should theoretically be flat, and the valuation of equities will be skewed until this is true or nearly true.

  46. cognos says:

    DiggigyDan –

    As society increases in wealth and capital stock… risk-free rates decline and PEs increase.

    Imagine the extreme case when society is very wealthy. Only low low returns to average capital (and an ultra-low risk-free-rate) will encourage risk-taking, entrepruneurship, and a natural turn-over in the pools of wealth. This is also necessary to encourage work amongst wealthy societies.

    Said another way… very large pools of wealth ($10B+, $100B+) are extremely risk averse. They want to exist forever. Why should they earn any excess returns on low-risk capital?

    Japan is ahead of the rest of the world on this curve.

  47. DiggidyDan says:

    I would add that the last time stocks seemed greatly undervalued per my calculations was 1982 local minimum. Since then, they have been undervalued at times, but not by much. The Devil’s Bottom just peaked below fair value in historical terms.

  48. DiggidyDan says:

    Our society is not increasing in wealth. It is increasing in foolishness.

  49. David Merkel says:

    @cognos — truth, P/Es are best related to corporate yields, not deposit rates or government bonds. And, you have to flip them to be E/Ps. Current E/P on the S&P 500 is 5.4%. A dividend yield of 2.05% is 38% which is close to the long run average.

    The longest corporate series that I have is the Moody’s Baa series — because of the growth inherent in stocks, for bonds to be the better deal versus stocks, Baa bonds need a 3.9% premium over the earnings yield, or a yield of 9.3% in the present environment.

    So, I’ll take it back, because the present Baa yield 6.45% augurs in favor of stocks versus bonds. Not crazy about bonds in this environment — few categories offer good risk-adjusted yields. Now, maybe both are overvalued vs. commodities, but that one I don’t know.

  50. Blissex says:

    “Something else is afoot.”

    The 401k is afoot. Isn’t all this related to all of us “investing” part of every paycheck regardless of the opportunities available? There is an entire industry based upon telling us to buy mutual fund shares with every paycheck. No matter what. And to never stop buying and never time the market.»

    That is surely one of the things. The Republicans and the centrists have read a few studies that show that house and stock owners fancy themselves rentiers and landlors and solidly vote for extremely conservative policies (see attached Norquist quote). Also stock and house ownership have been excellent delusions that have persuaded gullible middle class boomer shite voters that they can wish themselves a luxurious retirements on capital gains, and f*ck everybody else and get rid of handouts to the exploitative parasites in the lower classes. After all the two big deals in the past 20 years have been the drastic downsizing of handouts to the unemployed (the “welfare queens” and “strapping young bucks”) and the oversizing of those to seniors (Medicare).

    But these are tactical considerations. The big question is why ever, in a period of increasingly bubbly corporate profits and stock prices driven also by a rise in PEs (even more than a rise in profits), the insider elite that owned and controlled most of the USA economy, would sell the family silver to the vast masses of suckers who have 401ks.

    As to this the IPO of Goldman Sachs is probably the single biggest symptom.

    The strategic view that I have formed is that the former owners of the USA economy are asset stripping its populace, and liquidating their positions in the USA economy as they see it as no longer a growth prospect. And since it is much better to sell at the top of the market, they have been engineering one top of the market after another, with Greenspan and Bernanke (and the governments of Japan and China) stoking the fire at every possible opportunity.

    The USA has been for a long time both a resources based economy and an industry based one, with the southern and western cotton and oil magnates and the northern and western American Production System on the other. The USA resource based side of the economy is shrinking, with peak USA slavery, oil and water.

    The peak of USA oil production in 1977 means that since then the USA has had to increase exports to pay for imported oil, and that is a very hard task indeed, with no easy profits from just pumping black gold off the ground, spreading them around to pacify the (white) populace.

    With these downwards prospects (despite some reprieves such as the Alaska North Slope for the resource side and the computer/software boom for the industrial side) the USA elites want to get rid of their USA-tied properties, cash in and invest in growth areas abroad, earning a comfortable rent. Better to do so during a boom than a slump. Bye bye suckers.

    A quote from Norquist on the political plan:

    Grover’s charge: An interview with Grover Norquist
    The growth of the investor class–those 70 per cent of voters who own stock and are more opposed to taxes and regulations on business as a result — is strengthening the conservative movement. More gun owners, fewer labor union members, more homeschoolers, more property owners and a dwindling number of FDR-era Democrats all strengthen the conservative movement versus the Democrats.

    And a quote from Landes on a similar strategy in the Netherlands a couple centuries ago:

    That Dutch towns did not shrink more was because rents and food prices fell and some poor relief was available; this was a matter of public order if not of charity. Besides, Dutch wages still topped those in surrounding lands, in large part owing to the resistance of craft guilds, and this gap drew cheap labor from abroad to compete with the newly unemployed. Increasing hostility and conflict found an outlet in strikes, until nothing was left to strike about

    Some of this may remind readers of the conditions in the United States in the last quarter of the twentieth century. As branches of manufacturing have shrunk before foreign competition, enterprises have discharged redundant labor or moved to lower-wage areas. New workers cost less than old, as the airlines know only too well. Poor immigrants have kept coming. Unions have struck, sometimes only hastening plant closings or transfer of orders to cheaper suppliers. (Mutatis mutandis, one finds similar developments today in western Europe.)

    So on Holland two centuries ago. The United Provinces pared and trimmed to meet the competition, but the best they could do was run in place. Many businessmen gave up the fight and retired to the country and to a life of passive investment. Incomes polarized between the rich few and the poor many, with a diminishing middle between them. Tax returns show that by the late 1700s, most wealthy Dutch were big landowners, high state officials, or rentiers. Gone were the prosperous enterprises of the “golden age”: employers were not confined to the middle and lower ranks.
    In the process, the United Provinces abdicated as world leader in trade and went into a postindustrial mode. Italy had gone that way before.

    More persuasive the argument from catch-up and convergence: other centers, advantaged by lower wages, learned to make the textiles and other manufactures that had been a mainstay of Dutch exports and shipping, and having learned, shut their doors against imports. In a world of mercantilist rivalry, navigation acts and protectionism were killing the old workshop and the chief middleman. No wonder the Dutch exported capital: they could get more for it abroad than at home.

    The annals of competition show entire national branches dragging and withering — not this and that enterprise, but the whole industry. Sometimes, having learned their lesson, the last members of the branch move away, generally to cheaper labor; that is smart, but also easy, and evidence more of rationality than enterprise. An sometimes, as in Britain and Holland earlier, enterpreneurs retire to a life of interest, dividends, rents, and ease.

  51. rootless_cosmopolitan says:


    “As society increases in wealth and capital stock… risk-free rates decline and PEs increase.”

    And since when is this relationship supposedly valid? Since the 90s? Or are you claiming, wealth and capital stock hadn’t increased until then? I can’t see the trend you claim in the time series of the P/E-ratio. I only see a big, big bubble for the last two decades:

    According to this, stock valuations are still near the maxima of previous cycles.

    Dividend yield has trended down since about the 60s. Before this, no visible trend, only variability around about 5%:

    And there isn’t any inverse correlation between P/E-ratio and treasury yield, or any correlation between dividend yields and treasury yields found in the long therm data, either. There were long stretches in history when treasury yields were equally low or even lower, but the dividend yields were significantly higher than today:

    So your arguments look pretty much like a rationalization why the current valuations are supposed to be the new normal and why we shouldn’t worry and go long in stocks for the long term now. (Actually, I am long, but only about 20% of my portfolio for short term trading).


  52. DiggidyDan says:

    RC, don’t argue with people who can’t understand basic calculus or statistics. See LEI post a few days ago. For god’s sakes people, a decline in the value of the first derivative is not an absolute decline, but rather a decline in the Rate of Change! Only when it crosses the Axis does this indicate an absolute decline! See also, my various chastisings upon the misuse of “Feedback Loop” terminology.

  53. [...] According to this chart from Barry Ritholz, shares have been, and continue to be, overvalued for two decades. [...]

  54. cognos says:

    Rootless says:

    “There were long stretches in history when treasury yields were equally low or even lower, but the dividend yields were significantly higher than today”

    I cannot help you. This is 100% INCORRECT. Why just look at 10-yr yields? Why not 5-yr? Why not bills?

  55. cognos says:

    David Merkel –

    I completely agree. A comparison with Baa corp yields is very valuable. It is also the case that leveraged PE and conglomerate purchases will drive some equalization here. (I.e. If I can “buy out” equity and finance it favorably… then this will drive price higher. Exactly what happened in the 1980s, 90s, and 00s… ‘leveraged buyouts” and PE transactions created many billionaires.). We seem to see steady $20B/week of M&A deals right now.

    I also think it is overlooked that the broad “index PE” is overstated. It combines some companies with large losses, either 1-time or persistent (AIG, C). These lower the E and increase the index PE across other companies that NEVER HAVE A LOSING Q (msft, wmt, aapl, hpq, pg, etc). However… are these other companies really worth LESS because AIG had some massive loss? (Answer – NO!). So its a helpful check to just looks at 10 of the largest companies and check the “PE” and the “net of excess cash PE”. In this environment… we have alot of 10-12-14x numbers on our largest companies.

    MSFT – 14-15x (despite holding 20% cash)
    HPQ – 11-12x
    PG – 16-17x
    XOM – 11-15x
    GS – 8-10x
    PFE – 8-9x
    AAPL – 17-19x (despite holding 25% cash)

    Again… point is simply that large concentrated losses in single companies (AIG) or a single sector (financials) mislead one to think the “E” is lower than it is…

  56. rootless_cosmopolitan says:


    “I cannot help you. This is 100% INCORRECT. Why just look at 10-yr yields? Why not 5-yr? Why not bills?”

    Please! Are you claiming now 5-yr treasures and bills delivered higher yields than 10-year treasuries over the long-term stretches of history during which dividend yields (with a mean of about 5%) were even significantly higher than 10-year treasuries (lower than 4%, or even 3%)? Check your logic!

    There is no correlation between treasury yields and dividend yields. If you claim otherwise, show us your data. I have showed mine (not really mine).

    And what about the other point, the P/E-ratio, which, you claim, increases in time, because of wealth and capital stock increases, to rationalize higher P/E-ratios nowadays? The Case-Shiller index doesn’t show anything like it. It only shows a still high-priced stock market, if one takes the mean and variability of the long-term time series before the extremes of the last two decades as a comparison.


  57. cognos says:

    RC –

    YES. Inverted yield curve is exactly the harbinger and driver of the first Great Depression. The Fed raised rates into the downturn (classic austrian / gold bug stupidity) and short rates were as high as 5% in EACH of 1929, 1930, and 1931. By then the debt-deflation cycle had set in and the rest of the decade was lost (no surprise rates were very low against low P/Es when the E was on the decline).

    The current “prime rate” of 3.25% is the LOWEST it has been since 1955 (a very good time to buy stocks!).

    The data you showed illustrated the perfect correlation of yields with PEs since 1975. With very high rates in 1975… and a steady decline to lower and lower rates since. This is the exact mirror of PEs. One can look at other countries whose rate structures peaked at different times and find the same mirror image with P/Es lowest at the peak of interest rates. Further, it is only logical… since if E/P is greater than Baa financing… buy outs and PE transactions become self-financing and print billions (esp into growing E). But hey… not knowing / seeing this would only cost you LOTS of money since 1980. Keep thinking about it however you want.

    Finally… any comparisons of the “stock market” with that of 1910 or 1900 is super silly. Do you understand what it meant to “invest in stocks” back then? No phones. No planes. No computers. No transparency. Less than 1% of people were probably invested in stocks. Its just a non-sense comparison. Modern financial markets have essentially transformed about every 10-years. Understading fundamentals of “cash-flow” and “financing” are probably more important than broad 100-yr or even 50-yr comparisons.

  58. sparrowsfall says:

    Not so hard to explain: for the last 30 years–the age of The Reaganomics Strategy–we’ve been on a nonstop binge of Keynesian stimulus. (Do I really need to mention the word “hypocrisy”?)

    Note the inflection point: 1981.

  59. rootless_cosmopolitan says:


    “Inverted yield curve is exactly the harbinger and driver of the first Great Depression.”

    We aren’t just talking about this time period, what I said is also true for the time after WW II until around 1960. Where the yield curves inverted then, too?

    “The current “prime rate” of 3.25% is the LOWEST it has been since 1955 (a very good time to buy stocks!).”

    Around 1950 was a good time to buy stocks. P/E-ratios were in the single digits and dividend yields were high. Nevertheless, treasury yields were very low. Right the opposite of what you are claiming regarding the alleged relationship between treasury yields and dividend yields.

    “The data you showed illustrated the perfect correlation of yields with PEs since 1975.”

    You seem to like to found your views on spurious, only temporary correlations and sample-size-one-statistics.


  60. cognos says:

    Hmm… RC –

    I am looking at exactly the chart you referenced… PE in 1955 looks like ~18x? Over the next 10-yrs I believe total return was >150%. Sure dividend yield was 1% pt higher than it was today. So… maybe total return over the next 10-yr is 125% instead?

    It makes 0 sense to look naively at two 100-year charts and try to draw conclusions… nothing is (or should be correlated). It makes no sense to include the depression 10-yrs in the “avg PE” or any analysis of interest rates. Do you understand what life was like in the depression? Do you understand what life was like in 1900, 1910? The comparison is silly.

    Dont you find it interesting that PE bottoms at exactly the point where 10-yr yield tops? 1981, 82? Combine that with ANY logical understanding of debt/equity financing choices… think for 1 minute. Open eyes. (Check other markets… PE often bottoms where rates top. Argentina, Mexico, etc)

    Finally, there are two major mistakes we want to avoid:
    1) Buying at tops, when everything looks perfect but value is 2x overstated
    2) Not buying at moderate prices into recovery and growth periods

    I find your logic and analysis would’ve made mistake #2 consistently since 1985 (and in 1955). Missing those runs is impossibly painful. S&P500 was roughly $50 in 1955. It was roughly $150 in 1985. It was $500 in 1995. Why use empirical analysis that consistently misses on #2?

    What mistake are we more worried about today #1 or #2?