Friday, October 18, 2013

Stock Prices & Debt Rise: The Fundamentals Needed To Support Both Have Not

The following graph is one of the best I have come across to help visualize why the U.S. stock market has experienced the rise in prices over the past two years. Since September 30, 2011 the S&P 500 has risen over 50% while the Earnings Per Share on those stocks have risen by only 12%.


This means that rising prices have been due exclusively to P/E expansion (investors paying more money for the same level of earnings). This can be used to measure "froth" in the market. This chart is now a few weeks old and with the S&P 500 hitting a new all time record high in yesterday's trading session (and profits most likely falling due to the slowing economy) the gap between prices and reality has diverged even further.

In the real economy the same process is occurring with debt and economic growth. The red lines show the debt taken on to stimulate the economy and the blue lines represent the resulting growth.


Both these charts represent unsustainable trends. Either company earnings must skyrocket to meet the current prices paid for those earnings and economic growth must skyrocket in order to pay for the debt taken on, or both will meet gravity.

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