What's the one main driver for stock market returns? It's got to be economic growth, right? Growth is paramount to the increase in stock prices. After all, that's what we're told every single day by the financial media.
Actually, according to a new book by Crestmont Research's Ed Easterling, that's basically wrong. The single biggest determinant of stock market gains is the trend in inflation. His new book, Unexpected Returns: Understanding Secular Stock Market Cycles, is destined to be an investing classic.
Reading further into Bill Mann's review, this book is a follow-up to Mauldin's Bullseye Investing. And if you replace the term "inflation" with the term "p/e" it all becomes a little clearer. The bull market from 1980 to 1999 was driven by a p/e expansion from 7 to 23.
What about now? As expected from a follow-up to Mauldin, the premise is that the current p/e of 20 is still high historically which would would mean a bear market is mathematically likely to follow.
My take is that though the p/e of 20 is high, the current interest rate is still low and so the market isn't all that overvalued if at all. But with the rates still in a general uptrend, that thesis is slowly eroding.
For more, see the article on Vandeberg.
[8/28/05] An article in Barron's makes the same case that "the major determinant of stock-price returns
isn't growth in corporate profits, but rather changes in price-
earnings multiples". I'm trying to verify my own statement above that the p/e expanded from 7 in 1980 to 23 in 1999. The only 23 in the article I see now is that it was the p/e in 1965. Maybe I was confused. Looking at Barra, I see the p/e for the S&P 500 at the end of 1999 was 34. In 1980, it was 9.40. In 1979, it was 7.58. Barra's data goes back to 1977.
[2/23/05] Vitaly Katsenelson looks at Unexpected Returns
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