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Dr. Paul Price
Dr. Paul Price
Articles (513)  | Author's Website |

Stocks: Not Expensive in a ZIRP World

February 27, 2014 | About:

Don't fall prey to the hype, stocks have room to run.

Bears love to cite the market’s slighter higher-than-typical P/E ratio as a reason why stocks are overpriced and set to fall.

They fail to take into account the almost total lack of attractive, normally available, fixed income competition. The Fed’s ZIRP (Zero Interest Rate Policy) has turned bank certificates of deposit into a cruel joke on investors.


Note that it takes $100,000 minimum to secure that fantastic 1.4% APY (pre-tax) offered on a three-year CD. Even that rate guarantees a loss of buying power on an after-inflation basis, on the official Bureau of Labor Statistics’ (BLS) CPI-U figure.

Risk-free returns have morphed into return-free risk.


Use the old rules to calculate CPI and you’d get the Shadow Stats picture of the rise in the true cost of living. My personal experience says the BLS version should be more properly labeled as BS.

Our leaders can’t afford to publicly tell the truth. If they fessed up they would be forced to dramatically increase social security payments, government pensions and salaries.


Government and investment-grade bonds are no better deal than bank CDs in terms of current yield. Junk bonds might tantilize by comparison, but they subject investors to much of the risks of owning equities.

If you are going to take on that volatility, why not simply own stocks?

The chart below adjusts P/E expectations for various historically official inflation environments. The grey bars show the range expressed to +1/-1 standard deviations.


When looked at in this way, present day stock valuations appear to be a bit lower than is justified.

True inflation that is much higher than publicly acknowledged implies there is even more upside for equities just to get back to a normal relationship with realistic cost of living adjustments.

Mr. Bernanke and now Ms. Yellen have made owning stocks de rigueur if you hope to preserve your wealth over the long haul.

Disclosure: Long equities; I own no bonds.

About the author:

Dr. Paul Price


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Rating: 3.9/5 (11 votes)



Feo1966 - 3 years ago    Report SPAM

Japan has had ZIRP policy for years. How has their stock market performed in the last 25 years?

Dr. Paul Price
Dr. Paul Price - 3 years ago    Report SPAM


Any factor that is a constant can be ignored in terms of cause and effect.

America did not have ZIRP until after the 2008 crisis. What stocks have done here, without fixed income to compete with, is well documented.

AlbertaSunwapta - 3 years ago    Report SPAM

I tend to agree with you that ZIRP is rocket fuel* however I would expect that one country's ZIRP benefits would eventually be undone through competitive forces as competing countries pursue other means to competitive currency devaluations to maintain their, often excessive, trade surpluses. At some point those competitive forces should narrow the wide profit margins low interest rates initially create.

* We've essentially had falling interest rates ("disinflation") since the early 1980s which have helped power stocks to ever higher levels. This longer term falling interest rate trend capped off with ZIRP has created a once in a lifetime return situation for bond holders. A dreamworld for them. That game for both bonds and stocks is now essentially over unless rates fall to zero and go negative. We now need a new game in town to drive stocks forever higher. That may be inflation protection.

However, I wonder what the gaming of CPI (substitution, chained-CPI, etc.) which knocks the reported rate down will lead to should a disinflationary trend continue. What otherwise might be zero to mildly positive inflation rate under the old measures starts coming in as scary deflation numbers under the new methods even as people substitute their dog food for hamburger. ( Essentially, reality reverses but the gamed numbers don't reflect it. In other words, if they prove too successful in lowering reported CPI in a zero to low growth environment, what do they do?)

Shaved_head_and_balls - 3 years ago    Report SPAM

The trailing P/E of the SP500 is roughly 20 (as reported earnings). If you exclude the years since the early days of the 1990s stock bubble, a P/E of 20 was a rare occurrence. Besides, single year P/E's have no correlation with future returns. Only other valuation metrics such as CAPE have any degree of reliable long term correlation.

I'll bet the author made similar rationalizations about market valuation in 1999 and 2007.

AlbertaSunwapta - 3 years ago    Report SPAM

A PE of 20 or more has always been one my red flag as well. (One of my old world measures however we're now in a world of truly massive government and quasi-government intervention - and that's globally so.)

The bottom line is that ZIRP is now and the market is forward looking. The benefits of falling interest rates have the greatest direct impact on earnings when companies lower their cost of debt. Once this has worked through the system then it's debt expansion that is needed. (Confidence in the future is then the most needed ingredient. Yet I keep hearing the word: deleveraging, so if we hope to pull future consumption forward as "artificially" low rates do, we need the right entities borrowing and the right spending to occur. I would guess that right now, much of the borrowing is being captured by the financial economy and not the real economy as in housing, capital investing, etc.) If ZIRP is maintained, I would guess that it's value can be ignored as it's already built into everyone's financials and we're then back to assessing market prospects based on all the other earnings drivers (tax rates, sales-inventory turnover rates, margins).

On a similar note, in about 2009 Buffett said that the secret to recovery was 'getting the money into the hands of those that would spend it'. (Hussman and others have had similar focuses as in not bailing out the bank bondholders but instead the mortgage holders.) I'm not so sure the world has been very successful in achieving these sentiments. That means there is a lot of potential upside for real growth in the real economy - someday - and that should be reflected in stock valuations. I don't know whether that optimism (or should I say, realism) is already in stock prices or not.

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