Lately, there has been a spate of research, analysis and commentary telling us that earnings are at a cyclical high and must revert. Stock valuations, therefore, are elevated and earnings will soon begin to fall, bringing stocks down with them.
This is neither a credible analysis nor a method of valuing equities. Rather, it is an interesting narrative containing two predictions, and generally fails to acknowledge multiple unknowns and variables. (Let’s hold the question of whether anything as complex as the markets can be predicted with a single variable for another time).
Allow me a few more words to explain. Many of the traditional valuation methods rely on two or more variables. For example, price-to-earnings ratio uses both stock prices and earnings to determine if a company or market is cheap or expensive. This raises the obvious problem — obvious to anyone who is not innumerate — of forecasting one unknown by using a second unknown.
Why is that? . . .