Still Superman, but without the cape

[1] But smarter people than me disagree, like Cliff Asness, who suggests that P/E’s don’t do a great job predicting earnings growth, which he suggests counters the argument that tomorrow matters more than yesterday.

[2] And yes I know we are looking at nominal yields and not real yields, so we’re committing a bit of apples and oranges sin ourselves, but our allusion still holds if we make the correction.  The World Bank estimates a “United States Real Interest Rate” adjusting by inflation as measured by the GDP deflator.  It currently stands at 2.21%, so implies a “bond P/E” of 45.3x. In 1981, it was 8.72%, so a P/E of 11.5x. So, in 1981, the Shiller P/E traded four multiple points below the real yield on bonds, and today it trades a full 12 points below.  Still cheap.   Moreover, in both of these periods (amazingly) the Shiller P/E traded at a ~30% discount to the bond P/E.  So tell me interest rates don’t matter…

[3] The smarter “CAPE doomsayers” will point out that there are duration arguments across the spectrum of securities that comprise an index, and that there are scenarios where individual stocks (and perhaps the market if dominated by these stocks) may be “cheap” vs. interest rates, but actually expensive on their own.

[4] The other thing worth thinking about is that the FAAMGs currently represent a significant weight in the S&P 500.  Not only does this distort things a little (maybe), but basically, these FAAMG names, especially Google, Amazon, and Facebook have introduced game-changing business models unseen before by Mr. Market.   And they got big quick (I mean, they are all bigger than Exxon now, which has been around since John D Rockefeller started Standard Oil of New Jersey in 1870), basically in the blink of an eye.  So, when someone so new and special grows so rapidly, looking back on a ten-year horizon really overstates how expensive the market is on a CAPE (especially when said offenders represent a mid-teen weight in the index).

You think Facebook is expensive today with trailing adjusted earnings of $5.89?  Well, nine years ago they printed EPS of $0.10, so they are on a historical 2009 P/E of 1,850x!  The S&P doesn’t go back and recreate ten years of history for any new entrants, they just delete someone and add someone new – so when the likes of Facebook are introduced to the index (as a reminder, it just happened in 2012), they come in with whopping market caps against some deleted loser that probably was by definition on its earnings’ knees, also inflating the Shiller CAPE.  Again, apples-to-oranges, or should I say Apples-to-Exxons.

[5] The standard deviation of trailing twelve month averages of monthly observations over the previous ten years to March of 2008 was 18.3.  Over the next twelve months, the average dropped by 48.4, and the actual monthly figure dropped by over 60 points (from real earnings in March of 2008 of 69.26 to 7.90 in March of 2009).

[6] I have no idea why “ten years” stuck as the Shiller CAPE lookback period, and why it wasn’t five years or 15 years (or 9 or 11), but it stuck nonetheless.  My concern is similar to my argument about the silly 200 day moving average adored by noise traders.

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