RESEARCH ON THE STOCK EXCHANGE

The Wall Street, London and European equity markets have been through a terrible boom and bust

At its height, whichever way you looked, the Indexes were at least twice as high as would be justified by reasonable expectations of profits and growth.

Has the crash gone too far?

It is impossible to predict when markets will actually turn, but it is possible to calculate, by means of fundamental economic theory, a range of reasonable values for the average Price-to-Earnings Ratio.

where p = long term ratio of earnings to assets (ie profit rate ie internal rate of return); g = growth rate; i = interest rate, e = ERP.

TABLE 1

HISTORICAL DATA AND FUTURE ASSUMPTIONS
	GDP per head	Population	GDP
*Actual Growth Rates 1975-2002*
UK	1.95	0.32	2.27
Euro	2.10	0.19	2.29
US	2.20	0.91	3.11
*Assumed Future Growth Rates*
UK	2.25	0.00	2.25
Euro	2.25	-0.50	1.75
US	2.50	0.50	3.00
*Real Short Term Interest Rates*
	1985-2002	1997-2002	Assumed Future
UK	4.70	3.50	2.80
Euro	3.22	2.50	2.80
US	3.82	2.80	2.80

TABLE 2:

RANGES OF 'FUNDAMENTAL' PE RATIOS				Average of four PE's	Current PE	Current less Average, %
				UK
Growth Rate	0.023
Interest Rate	0.028	*Risk Premium*
	*Profit Rate*	*0.025*	*0.035*
	*0.070*	22	17	21	19	-10%
	*0.100*	25	19
				EURO
Growth Rate	0.018
Interest Rate	0.028	*Risk Premium*
	*Profit Rate*	*0.025*	*0.035*
	*0.070*	22	17	20	17	-15%
	*0.100*	23	18
				US
Growth Rate	0.030
Interest Rate	0.028	*Risk Premium*
	*Profit Rate*	*0.025*	*0.035*
	*0.070*	25	17	23	20	-15%%
	*0.100*	30	21