The Forecasting Folly Of Equity Valuations And Earnings Growth

Tyler Durden's picture

As we have painstakingly pointed out, rising equity markets in 2012 have mostly been a function of rising multiples applied to relatively stagnant earnings.


While JPMorgan's CIO Michael Cembalest would have given odds no better than 1 in 4 of a 17% advance in the S&P this year, he does note that forecasting annual equity returns is an entirely treacherous (and we add foolish) exercise as real return variation has completely swamped industry expectations for the last 60 years.


The traditional Graham-Dodd/Shiller valuation model makes equities look expensive currently, but Cembalest notes, valuations might not be the driving factor at this point.


The debasement of money by the Fed has altered the calculus of investing for many participants, and not necessarily for the better (as he notes ongoing work that hints at since the Greenspan/Bernanke era of negative real interest rates began, stock market volatility is even higher than before the creation of the Fed in 1913).

Of course, by driving interest rates down and promising to keep them there, a 7% nominal equity earnings yield (i.e., a 14 P/E) is transformed into a more compelling investment - but critically (especially for social and political reasons) the 'value' of this adjusted earnings yield is questionable given the earnings boom is derived from extraordinarily weak labor compensation and potentially unsustainable demand from Europe/China.

The growth of corporate profits has delinked from nominal GDP growth, a departure from past cycles.


This is unfamiliar territory for investors, since it suggests that you should just ignore weak domestic growth concerns and watch profits keep rising. The political and social risks of this trend are self-evident.


Source: JPMorgan

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The Alarmist's picture

A bucket full of holes will still fill if enough liquidity is dumped into it in a short enough period.

Ness.'s picture

"in the abundance of water, only the fool is thirsty."

Jah Bless Bob Marley


Hedge accordingly my friends.

Daily Bail's picture

Ron Paul: 'Forget A 3rd Party, We Need A 2nd Party' (CNBC)

Earlier today on CNBC.  Sorry for the threadjack, but this is pretty fucking awesome.

Yen Cross's picture

 Back in the day Cembalest would have been called an Alchemist. Those guys were pretty good at regularly blowing themselves up.

ekm's picture

The market right now is exactly like what link shows. In the old times they called it Alchemy, in the modern times they call it Pyramid Scheme.


Duke of Con Dao's picture

sorry for the threadjack also.... in the future I will say this:

here's Obama on the Folly of Forecast:

disabledvet's picture

How do I quantify Fukushima, the collapse of the EZ, the Arab revolt and quite probably the collapse of the Communist Party in China? And of course I can't. Does these extraordinary events...only covered here...and only analyzed and covered by me Disabledvet(trademark...all rights roar lion roar!)...mean anything beyond "this is really big shit man and I think it's really cool that we're talking about it...cuz it ain't phi king bullshit either!" Who the hell knows. I say "bullish for equities" and let the market be the Judge. So far so good...spectacularly so actually. Unfortunately I do agree "we need companies that can make trillion dollar profits"...and that strike me as a tall order since none of them pay taxes anyway.

Monedas's picture

I like the sound I make when I pee in a tin can !      Liquidity .... Bitchez !

helping_friendly_book's picture

We are doomed!

Just spend it now and go on the dole for retirement.

I'll probably retire in Macedonia. Only place I can afford.

I am buying plane tickets to travel while the Bernanke bux still have some value.

San Francisco tomarrow.

China in December.

Puerto Rico in the Spring.

I'll just have to smuggle for retirement. Or work the prescription painkiller doctor scam. Grow weed in the crawlspace.

Whatever it takes to survive. 

Still a wonderful life. Broke but blessed!

zorba THE GREEK's picture

Macedonia is nice, but Laconia is warmer and more scenic. 

Monedas's picture

Anthony Quinn and Norman Bates starring in "Zorba the Geek" !      I retire Thessalonika, Bitchez !  I like the jelly fish wrapped in grape leaves .... mmmmmm !       Joe Biden .... I spasta yo' face !

zorba THE GREEK's picture

When the stock market crashes, a lot of pundits will say we

saw it coming, all the signs were there. But now many of them

are calling for new highs and saying "Don't fight The Fed."

I personally, prefer to own physical PMs and sleep like a baby

every night.

helping_friendly_book's picture

I hope you live in a really big city and can maintain your anonimity. I am afraid, for my life, of PMs. I have had friends of my family murdered for their collection. 

Once the animals find out you have resources they tend to try and take it from you. The gov't included.

Good luck trying to spend it. 

Be careful and may the spirit bless you.

swabeyjw's picture

So what next:

1) Stocks down and then interst rates up or 

2) Interest rates up and then stocks down or 

3) Liquidity vaporization and they both go down or

4) Inflation with stocks/commodities up and bonds down or

5) Currency reset and hard asset are some hold on wealth

It is not what we don't know. It is what we know that is not so... reflexivity just flows

jaffa's picture

Depending on where you live, The weather people can not predict the weather any better than three hours in advance.I have worked construction for the last 30 plus years and you are better off looking at the radar screen and judging for yourself.

Even with all the Doppler radar and multiple computers they still can not predict it accurately.I can not count the times I have sat here in the morning watching the weather man tell me zero percent chance of rain, while I look out the window watching it rain. Thanks.
krill oil thins blood