This is among the best discussions I've ever seen on MMM, so thanks for that.
The Shiller earnings yield (1/ShillerPE) is 2.9% for stocks, and 10-year treasuries yield 1.62%. Both seem abysmal and dismal, but the number for stocks may not reflect future returns in the same way the treasury yield does. I'll make the best case I can make for stocks, but I simply cannot make sense of the bonds.
Note that in post-recession years, the S&P 500's earnings growth tends to leap above 20%. 2003, 2004, 2009, and 2010 were banner years for earnings growth. The average of the growth rates across those 4 years is 97% per year! When stocks post growth rates >20% for a couple of years in a row, it tends to make our judgments about PE ratios and Shiller multiples obsolete quickly. I.e. even if one buys at a post-recession time with a horrible PE ratio, the subsequent fast growth has always made up for it. And that historical note is about times when the government didn't drop thousands of dollars in the bank accounts of hundreds of millions of people.
https://www.multpl.com/s-p-500-earnings-growthIf the S&P's earnings rise from the 2020 number of $98.25 back to the 2019 number of $139.53, that would be an earnings "increase" of 42% and even this seemingly high number would not be outside historical norms. If the index's price didn't move, its PE ratio would go from 39.4 to 27.73, a drop of about 30%. Suppose we have another year of 20% earnings increases in 2022 - again this is not a historically unusual 2 years post-recession number. Our earnings are now $167.44 and if the S&P's price didn't move the PE would be 23.11, a drop of about 17%.
Suppose the price
did change, and we settled at a PE ratio of 30 for the S&P500 in 2022. The S&P in 2022 would be (167.44*30=) 5,023, a price increase of 29.3% even as the PE ratio decreased by 24% in only 2 years!
https://www.macrotrends.net/1324/s-p-500-earnings-historyAll this reiterates what we learned in accounting class: Earnings are the tip of the iceberg and in percentage terms they are highly sensitive to modest changes in income and expenses. Net profit margins for S&P500 stocks tend to be around 10-11%. Stated another way, earnings have 10x to 11x leverage to changes in income and expenses. This is the case for explosive post-recession earnings growth.
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If we think of recessions as periods of major cost-cutting, efficiency-investments, reductions in typically-wasteful mergers, layoffs of less-effective employees at the same time the market is flooded with talented and hungry candidates, reduction in compensation expenses for stock options, retention of dividends, etc. then we can see recessions for what they are: the foundations for a period of faster earnings growth. I'm particularly excited by early reports that 30-40% of office workers will stay working from home. The reduction in corporate costs and increase in economic productivity from this one pandemic-inspired change will rival the introduction of the personal computer in the mid-1990s and drive earnings growth for a decade - not a joke, dead serious.
But again, I can't explain why anyone would buy treasuries yielding 1.62% but a national bank hedging its currency or dollar denominated debts, or perhaps a euro or yen vs. dollar carry trader.