one of the things that has charaterised the bull market is the high and increasing profit margin level - big techs have astounding profit margin compared to what we had previously known that it overall it increased the S&P margin by a few percent past anything we had seen before in just the last few years. This has kep the vanilla p/e looking reasonable while leaving it expensive on many other metrics like price/sales and buffett indicator (price/GDP) as well as the CAPE10 variant.
I agree. As early investors in Microsoft learned, when your cost of good sold is almost entirely a fixed cost, and you can copy software for almost nothing every time you make a sale, then margins and profits can go through the roof. Additionally, growth is uninhibited by physical constraints, such as the need to build distribution networks. Do such companies deserve a higher valuation than, let's say, a steel mill or a tractor manufacturer? Definitely. What happens when the market becomes dominated by such high-margin, growth companies? The indices get a high PE ratio and the rapid earnings growth, in addition to higher stock valuations, blows up the CAPE ratio. Eventually the indices look like a fast-growing tech company themselves, and are no longer comparable to the indices of decades ago.
So maybe the value stocks
@MustacheAndaHalf cites with a PE of 14.3 are a decent proxy to compare with value stocks in earlier decades to decide whether stocks are expensive, and maybe CAPE is too distorted by changes in the composition of the indices to be of use?
It's not just big tech either, many established companies were able to push up their profit margins just through financial leveraging due to the cost of capital going so low.
Yea, this terrifies me. When interest rates are low, the way to optimize return to stockholders is to increase leverage. A popular management trick of the past couple of decades has been to borrow from the bond markets and use the money to buy back stock. Obviously there is a tipping point where leverage no longer adds value, but that tipping point is higher when interest rates are lower. What happens if there is an increase in rates after everyone has been doing this a while? Then, companies across the markets will be motivated to pay down debt, because the optimal capital structure will be a lower debt to equity ratio when debt is expensive. De-leveraging costs a fortune. It would either pull cash away from stockholders or dilute them. If de-leveraging could not be done, such as in cases where the company lacks the earnings to pay down its debt quickly, then stockholders would have to give back the capital gains they've enjoyed for many years and companies would become trapped in debt. A rising-rates, falling-earnings environment would trap a lot of companies.
Thus, if rates are rising, I have to think about the companies I own either de-leveraging at great cost to my cash flows, or even worse, not de-leveraging and sitting around helplessly while earnings get consumed by ever-rising interest expenses.