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Tuesday, June 06, 2006

The overall US stock markets are...

...finally not overpriced based on the historic average P/E ratio of stocks and the estimated P/E ratio of the S&P 500. If we look at the numbers, we see that the estimate for core earnings P/E for the year 2006 at 16.54, which is pretty much the historic average of P/E ratios. I prefer the core earnings number since real stock options expenses have grown enormously lately and it's better to use a number which at least attempts to account for them.

Of course this says nothing about earnings in the future, but I would argue that in the long term, they will continue their slow steady march upward at about the same rate as the overall economy. They may grow faster as US listed companies have market share in big fast growing countries like China and India.

It's been more than 10 years since P/E ratios were this low. Buffett has argued that the markets tend to over-correct downward (which argues that stock prices would continue to drop). I would add that the long-term trend (hundred years or so) is for steadily increasing stock P/E ratios, or at least less drastic downturns. That trend rests on how the general population views stocks and the stock market. The trend has gone from viewing it as gambling to viewing it as a vital ownership of the business sector and a key place to park money. I don't see that trend ending as we hold businesses more and more accountable over the decades and as people become more and more savvy about economics and business.

But there's always the possibility of all hell breaking loose and people panicking. But they're a whole lot smarter about things today than 80 years ago.

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