FinancialGauge
Independent Strategic Thinking
February 2011
Gauging Equities
Is higher earnings volatility reflected in equity prices?
The period from 1980 to 2000 witnessed falling rates and steady earnings growth leading to significant P/E expansion (i.e., stock prices rising faster than earnings). In contrast, high earnings volatility around a flattening trend has characterized the period since 2008, notwithstanding the sharp cyclical upturn in earnings. This is likely to persist in the aftermath of the financial meltdown and rising geo-political risk - suggesting a less favorable secular environment for equities going forward, especially in the absence of continued rate declines. (See our previous features – P/E Extremes, Equity Valuations and Equities in Transition).
Strategic Implications:
Higher earnings volatility with lower trend growth and upward bias on rates imply range-bound P/E’s between a high of about 20 and a low of 10 (based on trend earnings) - suggesting that current valuations are near their highs.
*Yoav Benari, “An Asset Allocation Paradigm”, The Journal of Portfolio Management, Winter 1988.
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This article is distributed for informational purposes only. All information contained herein should not be considered as investment advice or a recommendation of any particular strategy, security, investment product or financial instrument. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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