Interesting study on P/E ratios & expected returns

[Cb]

http://www.journalfp.net/jfp0202-art10.cfm

From the summary:

"What does this mean for financial planners? First, do not use current P/E ratios to predict short-term returns. Second, financial planners should adjust their long-term expected returns to reflect the reality of current market conditions. If current P/E ratios are high, expect lower long-term average returns and if current P/E ratios are low, then expect higher long-term average returns. Finally, if P/E ratios are at historically high levels, expect long-term average returns on stocks to be low but above those of long-term T-bonds and T-bills. So the best advice to give investors when P/E ratios are high could well be to expect lower returns but still stay with stocks."

[lpuzzle]

Posted by: Cb Posted on: Today at 2:08pm

http://www.journalfp.net/jfp0202-art10.cfm
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Good article - thanks for the link

[Prometheuss]

"Finally, if P/E ratios are at historically high levels, expect long-term average returns on stocks to be low but above those of long-term T-bonds and T-bills. So the best advice to give investors when P/E ratios are high could well be to expect lower returns but still stay with stocks."

This tracks with my expectations and matches what Bogle and the Sage from Omaha among others have said about future market returns. On the flip side, if one is in the accumulation phase as I am this is the silver lining to everyone else's dark cloud. I can expect to buy equities for the next ten to maybe twenty years at steady prices as P/E ratios decline until the next strong, sustained bull market sweeps prices upward again. The net effect is an enormous buying opportunity if you are in the market for the long run.

But then if you believe all this the same logic applies even if you are not accumulating retirement investmetns. You should let current equity investments that are not needed in the near term ride until earnings increase sufficiently to lure back investors and drive P/E ratios sky high.

Prometheuss