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Notes to myself, possibly of interest to others.
-- Bill Northlich

Tuesday, May 24, 2011

Corporate Earnings as Percent of "National Income". Case for Overvalued Market?

From Jack Hough, SmartMoney: U.S. stocks, despite having racked up a decade worth of typical gains in the 26 months after their recessionary low, do not look expensive. The S&P 500 trades at 15.3 times trailing earnings, only a smidgen above its historic average of 14.5.

...History suggests today's corporate earnings are unsustainably high relative to the size of the economy. The real price-to-earnings ratio, based on a more normal level of earnings, is well over 20.

To see why, consider a broad measure of America's prosperity called national income. It consists of corporate profits, worker wages, sole proprietor income and more

...corporations since 1929 have collected an average of 6.4 cents per dollar of national income as after-tax profits.

(From here: Right now, we're between 9 and 10 percent. There's only two points in history when we were this high before: one is 2006, that's just at the peak of the housing bubble, just before the recent financial crisis; the other was in 1929, just before the stock crash that kicked off the Great Depression)

... [Back to original]If earnings were to shrink to their historic average, the aforementioned P-E ratio of 15.3 for the broad stock market would rise to nearly 23.

...Robert Shiller uses a different method to detect exaggerated earnings. He calculates P-E ratios based on 10 years of earnings, just in case past-year earnings are unrealistically rich. His math puts U.S. stocks at 24 times earnings. In late 2007 at the market's peak they were 27 times earnings.
Bill: These two links show Mr. Hough making a case that based on an uncommon measure ("National Income"), the market is wildly over-valued. The market may well be overvalued - Shiller's reasoning on that is to me a sounder argument.

So what does the National Income stat really show? My take on this is that this is interesting, but only a feature of the crisis. We already know that real unemployment is above 20%, and has been. Mr. Hough's data only points out that we still have massive unemployment, as the "progressives" (Thoma, DeLong, Krugman, etc) have been pointing out forever.

Ie, that those who are making money now are making more, proportionally, than those who used to make money too, but are not now, does not seem particularly revelational.

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