Cam and all,
In the post “My inner trader returns to the drawing board” there is an Ed Yardeni quote about whether the “fair-value” PE could be double 15.0. Let’s do a quick and dirty thought experiment.
Playing around with a simple spreadsheet, and thinking of a dividend discount model for stock prices, earnings 1.00, (assumes a payout ratio of 100% or efficient reinvestment of retained earnings so common stockholders get it eventually), a 3% equity risk premium and a 3.67% long Treasury yield for a total 6.67% discount rate (fast and loose here) gives a price of 15, and a PE ratio of 15/1 = 15.
With long Treasury yields at say 1.5% the discounted value of future earnings is now 22.2 and so is the fair value PE ratio.
Then add the trillions of stimulus and Powell put. Say that takes the ERP to 1.84%. Now the discount rate is 3.34% and the PV of future earnings is 30, so the PE is 30. Fair value.
I conclude that the PE is only useful as a valuation metric when the discount rate for future earnings is stable. Long term charts of the market PE are not valid.
S&P 4000 anyone?