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Rip Van Wingle Theory Explained

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February 21, 2009 – Comments (0)

One of the things that I have previously said about my look at the markets is I looked at them and developed some sense of valuation and then I essentially went to sleep on them and didn't look for about 20 years.  And to wake up and take a look, well, the valuation was shocking to me. 

John Mauldin has this piece, "While Rome Burns," and here's a section from it:

Look at the table above. There were
only nine periods from 1900-2002 when 20-year returns were above 9.6%, and this
chart shows all nine. What you will notice is that eight out of the nine times
were associated with the stock market bubble of the late 1990s, and during all
eight periods there was a doubling, tripling, or even quadrupling of P/E
ratios. Prior to the bubble, there was no 20-year period which delivered 10%
annual returns.

Why is that important? If the P/E
ratio doubles, then you are paying twice as much for the same level of
earnings. The difference in price is simply the perception that a given level
of earnings is more valuable today than it was 10 years ago. The main driver of
the last stock market bubble, and every bull market, is an increase in the P/E
ratio. Not earnings growth. Not anything fundamental. Just a willingness on the
part of investors to pay more for a given level of earnings.

 Well, that explains it very well because I developed my initial perceptions in the 80s and if you were to look back at my earlier blogs a lot of them where ranting, "are you nuts, 3% earnings per share and all the risk?"  It just seemed to me that considering the market has risks one is nuts to pay more for a stock then what you could get for a guaranteed investment.  I didn't even like the 5% stuff and I could not have cared a less that they were so called "blue-chips..."

 

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