Why Stocks Are Expensive

The stocks-are-cheap argument proceeds from a few reassuring facts. Corporate profits are rising after having plunged over the past two years. The unexpected election of Donald Trump, which hadn’t been priced into the market until November 9, heralds an era of pro-business and pro-growth policy from Washington. More broadly, the financial crisis scared millions of investors away from stocks; now, as the business environment warms up, many of them will return, and the sheer volume of dollar inflow will push prices higher.

It’s a plausible argument based on observable trends. But Shawn has never favored that type of argument. Instead, he dissects the numbers, and right now they are not comforting. The S&P 500 is trading at a PE multiple of 25.3, which is far above historical averages. That multiple could be perfectly rational, however, if profits are about to explode, and Wall Street analysts are indeed predicting a strong rise. So what’s the problem?

The problem is that analysts tend to fall in love with the companies they analyze and overestimate future profits. If you aggregate their profit forecasts for the individual companies they cover, the result is usually way above the actual performance of the companies collectively – about seven percentage points above, says the FactSet research firm. The coming profit surge is by no means certain. The bulls like to note that certain industries should do much better this year, for example as rising oil prices benefit energy firms. But rising oil prices also impose higher costs and thus lower profits on other companies.

Bottom line, I think Shawn makes the more persuasive argument. Stocks are not cheap. But I also try to remember that even when the market is irrational, it’s perfectly capable of getting more irrational. Alan Greenspan notes that an investor who bailed out of stocks when he gave his famous “irrational exuberance” speech in 1996 would have missed 80% of the bull market’s gains.

I also try to remember that market milestones like Dow 20,000 are meaningless, and just because the index gets close to a round number doesn’t mean it’s about to hit that number. After all, investors got excited about Dow 1,000 when the index hit 969 in December 1965 – but it didn’t close above 1,000 for seven more years. Dow 20,000 could happen this afternoon, or years from now.

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What We're Reading Today

Marissa Mayer to step down from Yahoo's board
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Google contemplates selling its satellite business
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Valeant sells skincare brands to L'Oreal
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Mars buys animal hospital chain
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Transition Notes

Jeff Sessions confirmation hearing to begin today
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Ivanka Trump will resign from the Trump Organization...
...in an attempt to clear ethics laws as her husband, Jared Kushner, becomes a senior adviser to Donald Trump. Kushner will step down as CEO of Kushner Companies and as publisher of the New York Observer. The couple will not sell all their assets in those firms, however, instead saying they would make "substantial divestments" of some holdings. Fortune

President Obama says goodbye tonight
In Chicago, Obama will deliver his last formal remarks as president. It's a departure from previous presidents' final addresses, which typically took place in the White House. Officials say he will provide a "hopeful" vision of the future and is not expected to focus on policy.  CNN

Up or Out

Rent-a-Center CEO Robert Davis has resigned. He will be replaced temporarily by founder Mark Speese.  WSJ

Goldman Sachs has promoted Elisha Wiesel to CIO.  Business Insider

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Apple has asked permission...
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Spotify has a job opening geared specifically for the outgoing President
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