When Wilson substituted the 10-year inflation breakeven for the bond yield, on the reasonable basis that the hurdle we really want our investments to clear is inflation, he arrived at an equity risk premium almost exactly as low as at the apex of the dot-com bubble in 1999 and 2000. Using breakevens, and assuming that the current belief in a modest revival in inflation is correct, then stocks are as expensive as they’ve ever been. Yes, they were a great bargain last March. They’re not anymore.
Does the great rally in earnings help the case for stocks? Not really. In the past week, expected profits for 2021 finally exceeded the earnings that were estimated for 2020 at the start of last year, according to Bloomberg’s survey of expectations. Meanwhile the S&P is up about 30%. The stock market must be discounting a few more years of great improvements in earnings per share. With a corporate tax hike in the offing, that looks most hopeful.
If we want to look at the prospective P/E in its own right, it provides little comfort. It jolted down in January with the move from 2020 to 2021 earnings, and we should ignore the spike at the end of last year . The current level needs to be taken more seriously, and suggests that the market is at a level only succeeded in the bubble years of 1999 and 2000:
Valuation provides no help with timing, and it is always possible for an expensive market to become even more expensive. The final madness of the boom at the turn of the century only really got going once the market had reached about the valuation it’s at now. But the sense that the bond market and valuation have made it easy to buy stocks seems to be worryingly persistent, even though it is no longer true. In broad terms, the equity risk premium has never been lower. To quote Wilson of Morgan Stanley, “while there’s no rule saying it can’t go lower, we think there’s low probability that it will.”
Survival Tips
The original podcast came out nearly two years ago, but Joe recorded a new episode last week after he succeeded in having the shrink of the title barred from continuing to practice. Also, the podcast is now to be turned into a sitcom also called The Shrink Next Door starring Will Ferrell and Paul Rudd. I suspect it will be rather a dark comedy.
Anyway, it's a remarkable tale brilliantly told. And for a survival tip, if you ever feel the need to seek therapy from a psychiatrist, make sure you agree on the bounds at the outset.
John Authers is a senior editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of The Fearful Rise of Markets and other books.
One great podcast I forgot to mention last week: The Shrink Next Door, featuring a lengthy investigation by Bloomberg Opinion colleague Joe Nocera into the bizarre manipulative behavior by the psychiatrist who lived (or appeared to live) next to him in the Hamptons on Long Island. He effectively took over the lives of his patients, lived in their houses, and took over the running of their businesses. It's extraordinary if macabre listening.