>Doug,
>I am confused by all this talk about how present valuations are based on a
>rate of profit growth (15%) that means in so many years profits would eat
>up all of GDP , if it continues to grow at its current rate (3%).
>1. Why and how are present valuations dependent on that kind of
>extended profit growth? Couldn't I buy at present values expecting no
>more than say a 7% profit growth rate as long as I think buying on the
>Nikkei poses great risk of destruction of my capital or bond purchases
>are subject to great risk of loss of par (?) value (I guess that means I
>would be anticipating higher interest rates in response to dollar fall
>from current account deficits)? Perhaps investors just aren't expecting
>much in the the possibilities of returns elsewhere and willing to accept a
>lower rate of return on stocks or are simply paying premium for what they
>take to be safety (and at any rate easy exit) from the highly liquid US
>stock market? Didn't Brad deLong mention that possibility?
You could buy on any assumptions you wanted. Conventional valuation methods are based on assumptions about growth, interest rates, and volatility. A 7% profit growth rate is still faster than GDP trend growth, so you're betting on the profit share of GDP continuing to grow. If you expect profits to grow in line with GDP, then you'd be paying 30 or 40 times earnings for 3-4% returns, which would suck, since you could do better with T-bills at no risk to your capital. Of course anything could happen (sorry for the qualification, Carrol!).
The Fed paper whose abstract I posted (and to which the NYT article refers) shows that firms would have to devote all their profits to buybacks to keep up the present pace, and buybacks have been one of the things behind the bull market. Add to that the overstatement of profits because of the failure to account for options claims, and it's hard to justify a staight-line extrapolation of the present.
>2. perhaps there's great expectations of profit rate growth from overseas
>operations, and this is allowing profit growth expectations to race ahead
>of US GDP growth rate expectations.
Like I said, profitability peaked 3 years ago. Maybe it'll bounce back.
Doug