What’s the Market’s T/E Ratio Lately?
Yes, I said T/E ratio.
Not P/E, as in the ratio of price to earnings; but T/E as in the ratio of trust to earnings.
The P/E ratio of a company, industry, or market, signals many things. High P/E ratios may signal expectations of high growth, understated earnings, or low returns from alternative asset classes.
But P/E ratios also reflect levels of trust that certain things will continue to work:
• The law of gravity will not be repealed (at least not before Q4).
• The sun will set, as we anthropomorphically put it, in the west.
• Banks will still lend money to each other
• Interest rates will remain positive
• Oopsie…
P/E ratios, in other words, have a lot of co-variance with what we might call the Trust/Earnings, or T/E ratio. But while the numbers may overlap, they are not the same.
It’s one thing to have a certain level of confidence that CitiBank will work its way out of its difficulty. It’s quite another to trust that borrowers will continue to feel the same moral obligation to pay down a mortgage when 11% of borrowers are underwater. Or that they will trust their fellow man with their money in the form of government-insured deposits (interestingly, zero percent interest rates are bullish for institutional trust–it says whole lots of people find government-issue paper at zero to be safer than investing in anything).
This blog writes mostly about personal trust, not social or institutional trust. But they are related, and powerful.
Our economic and commercial world is astonishingly inter-related. If we start losing trust in the complex ways we have evolved to cooperate with strangers–banking, insurance, credit–we are all at risk.
Fortunately, we have personal, human habits, manners and customs that keep us in the habit of behaving nicely with others.
We need to make sure our institutions reflect those habits, not undermine them.
As for P/E ratios, the bad news is we are down considerably from the highs of 2002. The good news is, that was the height of the dot com silliness, and are now at the high end of average for the last 70 years.
Since no one has invented a T/E ratio (and I wouldn’t trust it if someone did), let me make a few assertions unconstrained by facts. Assess them against your own gut instincts.
The P/E ratio is much more volatile than the T/E ratio.
When the P/E ratio was in the 40s a few years ago, that was over-confidence, not over-trust. If anything, we saw the abuse of trust in commerce.
A P/E ratio now at the high end of normal might seem comforting, but I suspect that again Wall Street optimism masks not only the depth of the recession, but some erosion in the T/E as well.
A decline in the T/E is of more concern than a decline in the P/E. The world economy depends a whole lot more on us learning to trust each other—individually and collectively—than it does on interest rates.
For evidence, see the case of Japan over the last decade. Oh, you didn’t notice what happened with Japan? I rest my case.