S&P 500 is Really Cheap

COMMENT: Dear Martin,

Another element that strongly supports your view is that US equities will fly at some point in the future. If you take the trailing 10y avg real earnings yield from S&P500 (you can easily get them from Shiller’s site) and you normalise it by the 10 year US yield you get the attached chart.

We are at the same level of pre WWII when USA was an emerging market, now if we assume the normal range being between 1 and 1.5, rate may double and we would still be at the bottom of the range. This is without even taking into account any strong dollar cycle or sovereign debt crisis.

Having said that, earnings have been softening in dollar terms over the last few years but with a raising dollar which may have pushed people totally in the wrong direction.

Thank you very much for all you do.

REPLY: Yes. This is one of the views we track as well, but it is highly controversial. Many view the P/E ratio as proof that the market is overvalued, but the DOT.COM produced a P/E at 50. During a crisis when people are afraid to park money, the P/E will exceed 100 as it did with the 2007 crash.

Overall, there is a deep reflection of how cheap the market is today with low trading volume. It will not take much to shift capital flows from bonds to equities and this has nothing to do with its cheap price, growth, value, or any of the other scenarios that people rely on. We are in a different place — the preservation of capital.