E Things Are Different Post Lehman, Even If They Shouldn't Be

DJII Price 17,930 at 56% Discount to Value 40,452

Buy, and Take No Prisoners!

The shrill screams of the talking-head Cassandras hold that the stock market is about to roll over because the P/E multiple is too high, the earnings are falling, the yield curve is flattening and the coming recession is about to plunge the world into a never-ending downward death spiral.  

Despite all this noise, the DJII is rising strongly and there is an explanation. The whole point of investing in bank deposits, bills, bonds and equities is to get a positive return whether it be interest, coupons or dividends.

The greatest potential return today is in equities. On an after-tax basis they yield more than any high-grade U.S. debt instrument. This is very different from the years before Lehman. Investors must wake up to the enormous discount that the DJII is selling at relative to its dividend-discount value, which is at a record high and represents a better investment opportunity than in March 2009.

Earnings Recession Underway

Despite the DJII earnings recession and a flattening yield curve, the price of the DJII wants to move higher. Fear of recession is leading to the downgrading of earnings forecasts although the major drops are in energy sector, which should eventually be good for the rest of the economy as would a falling U.S.. dollar.

Expanding P/E multiples are often used as an argument that the DJII is overpriced. P/E multiples are widely believed to be forecasting future growth. In fact they are nothing more than a statement of the relationship between current earnings and the prices of shares. P/E multiples move towards infinity when earnings disappear during recessions. They say nothing about the future growth of earnings. 

It is a circular argument that the market is rising despite falling earnings, while it should not. Both developments cause a rise in P/E multiples. Price goes up which expands multiple and earnings decline which expands multiple even further.

DJII Dividends and 30 year T bond Yields Provide Answer

From the above it should follow that something else is having a more causal effect on the DJII price than earnings and multiples. Perhaps causes are to be found elsewhere. Changes in dividends and long term bond rates provide a much better explanation for the continuing rise in the DJII over the past 7 years.

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Moon Kil Woong 5 years ago Contributor's comment

Dividends are much more stable, however, even these stocks will be rocked by a downturn caused by the Fed's low rate policy that has created an even greater asset boom than Greenspan. Sadly, this spike has made it that much more impossible for the Fed to correct the downturn when it hits. Rather than learning its lesson it seems to be actively trying to recreate the last downturn and Yellen seems to be fashioning another great depression rather than trying to take measures to prevent one.

Gary Anderson 5 years ago Contributor's comment

The Fed can't correct downturns and can't even create a booming society because it can't stop inflation anymore either.

Moon Kil Woong 5 years ago Contributor's comment

The Fed should be able to help downturns by lowering rates. I agree, the way the Fed has made things now this is impossible. Likewise, I agree the rise of inflation, although the Fed takes credit for it, is not in the Fed's power and limits their ability now. Worse even has been the rise in bond rates which preceded the Fed's rate hike. The Fed is now behind the curve.

Gary Anderson 5 years ago Contributor's comment

I don't think long bonds will react much to little rate hikes. The demand for long bonds is insatiable.

Gary Anderson 5 years ago Contributor's comment

What if banks think they can't make money funding non energy projects? Won't that slow the entire economy? Just wondering, Tony.

Tony Hayes CFA 5 years ago Author's comment

Dear Gary,

If the banks will do nothing but sit on their $ 2.5 trillion of excess reserves then long rates will fall further pushing up the dividend discount value of the DJII. At some point the banks will have to move either into the real economy or into the equity market.

For more thoughts on this please visit:


Kind regards


Gary Anderson 5 years ago Contributor's comment

I hope the banks do take a greater interest in the real economy, but not with so many toxic loans as last time. Thanks Tony.