I recall Jeremy Siegel saying that the long term average PE for US stocks is about 15 but in low interest rate environments, it's higher, at about 19.It's certainly true that the average market multiples aren't the same inhigh interest rate environments and low interest rate environments.(the average multiples are also not the same in high barometric pressureand low barometric pressure environments)But prevailing interest rates don't change equity values.They only change the mood of the market by changing the apparent currentrelative attractiveness of equities and bonds.Thus changes in current interest rates might predict the short termdirection of the market, but they don't change the fair value of the market.Equities purchased at low multiples of trend earnings will give youhigh real returns in the next 5,10,20 years whether interest rates orreal interest rates were high or low when you bought, and vice versa.If an input doesn't change your returns, it isn't a factor for fair value.http://papers.ssrn.com/sol3/papers.cfm?abstract_id=381480Perhaps (just perhaps) a better way to slice it is to note that averagemarket multiples are higher when inflation is relatively normal versuswhen it's doing something which tells you the economy is broken.Say, inflation 0% to 6% might be normal but negative or super high are bad."Normal" times, trailing year inflation 0% to 6%:Average observed multiple of trend earnings since 1871 = 15.1x, average since 1940 15.8x("normal" inflation seen 56% of the time since 1871, 76% of the time since 1940)"Abnormal" times, trailing year inflation negative or >6%:Average observed multiple of trend earnings since 1871 = 11.5x, average since 1940 9.8xSince inflation is by this definition entirely normal right now onemight speculate that seeing a multiple in the ~15.5x range might make sense.My estimate of current on-trend earnings is in the rough neighbourhood of $73 which would put expected S&P level at around 1130 on that view.The downside of this happier viewpoint is that if/when inflation getsoutside the normal range you'd have to drop your expectations of"normal" multiples by 30% overnight. Ouch.I prefer to use a single long run average because you don't wake upone morning with an entirely different definition of "normal" or "fair".The average multiple of trend earnings since 1940 has been around 13.8x.13.8 times $73 would be fair value around S&P 1007 (in Dec 2012 dollars)Jim
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