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What is the New Normal for S&P Earnings

What is the new normal? This is the debate that is raging in hedge fund research departments around the world. I’m afraid that today’s equity investors are not taking into account some unpleasant new realities. The last thirty years have seen an average PE multiple of 15 times, and peaked at 20 times during the really great years. Unfortunately, this multiple expansion was fueled by an explosion in leverage. Even companies that hated debt had to drink the Kool-Aid to compete. Now we are moving in reverse on the leverage front double time. Debt/EBIDTA has shrunk from three times to two times in just two years. Even if corporations want to leverage now, they can’t, because the lenders have gone missing. If you wean the patient off of steroids, shouldn’t this mean that the range of PE multiples is permanently downsized? Should the new normal of 1-2% economic growth and an “L” shaped recovery demand an average of only 12 times, 10 times, or Heaven forbid, the eight times low we endured in the seventies? Logic like this makes today’s 13.4 multiple look frightening rich, and the stock market insanely expensive.