Are Stocks Cheap? A Review of the Evidence
- Fernando Duarte and Carlo Rosa
- A version of the paper can be found here.
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- h/t A. Seager @ Arbor Hill
Let’s now take a look at the facts. The chart below shows the weighted average of the twenty-nine models for the one-month-ahead equity risk premium, with the weights selected so that this single measure explains as much of the variability across models as possible (for the geeks: it is the first principal component). The value of 5.4 percent for December 2012 is about as high as it’s ever been. The previous two peaks correspond to November 1974 and January 2009. Those were dicey times. By the end of 1974, we had just experienced the collapse of the Bretton Woods system and had a terrible case of stagflation. January 2009 is fresher in our memory. Following the collapse of Lehman Brothers and the upheaval in financial markets, the economy had just shed almost 600,000 jobs in one month and was in its deepest recession since the 1930s. It is difficult to argue that we’re living in rosy times, but we are surely in better shape now than then.
All the models suggest equities aren’t that expensive on a historical basis.
The opportunity costs of capital (the bond alternative) is lower than it has ever been.
- Rule #1: Never listen to the Feds.
- Rule #2: Refer to Rule #1
Example: Bernanke pontificating on housing…