Stock Valuations Outrunning Profits Growth – And The Band Plays On

“We are still amazed by the chart [below], but it summarises the problem for those seeking to short stocks with fundamental weaknesses. In the last three years, the MSCI World Index has risen by 38% (11% per annum) whilst reported profits have risen by just 3% (that’s just 1% per annum!). As the events of last month attest, central bank actions–not profits–are driving equities forward.”

Andrew Lapthorne, Societe General

This quote is in reference to the first chart below that shows stock prices are outrunning profit growth.

The second chart is the Shiller PE 10 Ratio for US stocks.

Beside the corrupting influence of Big Money on politics and academics, the other pervasive problem in our society is managing to the numbers.

Although incentives have always been an issue, in the last thirty years it has become quite fashionable in modern management theory to set a few relatively narrow metrics and judge the performance of a manager by them.

While this is not wrong in and of it self, such a philosophy provides a source of great mischief if the metrics are excessively narrow, and therefore obscure the bigger picture and the health of an organization, a company, or even a nation.

I think we are all familiar with how incentives badly designed can drive counter-productive, short term behavior that can actually be destructive of the values of an organization.

I cannot think of a better recent example than the manner in which the Central Banks and their governments are managing The Recovery.

If employment is a metric, let us foster an economy in which a large number of jobs are created, that are low paying and part time.  This addresses the metric of unemployment, while ignoring the real reason for it, ie, the availability of jobs at living wages which will spur aggregate demand.

If inflation is a metric, let us follow policies of money printing and distribution in order to raise the prices of goods, ahead of the ability of the broad public to pay for them through wage and income growth.