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There’s scant reason for bullishness

There was a huge rally in global equities in the middle of October after markets reached six-year lows. The catalyst was the third-quarter earnings reports of US corporations. Most seemed to beat consensus forecasts.

Does this mean that the bear market that began in OECD equities in March 2000 is now over? I don't think so. Corporate profit growth will continue to be hindered by low margins. Combined with widening corporate bond yield spreads, this means US Inc is adding little value. Even though the S&P500 index has fallen nearly 40% from its peak, when corporate market value is measured against economic profits and book value, equities are still expensive. If the average of these multiples during the past 20-year bull cycle is taken as an indication of fair value, equities would have to fall another 25% to 30% before the stock market finally reached a trough.

US and European P/E ratios are still not attractive because the equity boom of the late 1990s was not justified by improved profitability. Labour took the lion's share of new-economy productivity gains. And new-economy technologies contributed to margin erosion by destroying corporate pricing power. That eventually created a negative gap between prices charged and unit labour costs.

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