Here is the money quote:
The price-earnings multiple is one key metric to judge valuations, though it suffers from some weaknesses. Since 1954, the S&P 500 P/E trailing multiple has averaged about 16.6. But this encompasses very high P/E periods, such as the 1950s and the 1990s and exceptionally low P/E periods, such as the 1970s. Using a simple average treats radically different periods equally, which is simplistic, naïve and wrong.
While the current market P/E is somewhat above average, that average is a meaningless mix of high and low interest rates and P/E multiples over very different economic environments. As anyone who has ever worked with a dividend discount model understands, high interest rates imply low P/E multiples and low interest rates imply high equilibrium P/Es. If we focus on those periods when inflation and interest rates were low, as they are today, the implied equilibrium P/E multiple is well above the historical average, but also above the prevailing multiple in today’s market. Indeed, with interest rates still close to record lows, the appropriate equilibrium for the market’s P/E multiple should be high. (emphasis added).
Note: This is only the second column at BV from Charles Lieberman, who is CIO at Advisors Capital Management. I am unfamiliar with his track record, but the entire piece is thoughtful, thought-provoking and worth reading . . .
UPDATE: This morphed into a full column, here
Stocks Aren’t Overvalued
Bloomberg View 22 MARCH 2, 2017