From Political Calculations:
Previously, we've shown that the stock market's expected dividends per share are the fundamental driver of today's stock prices. In fact, we even worked out the basic math:
In the equation above "P" refers to the average stock prices for a given month, while "D" refers to the stock market's trailing year dividends per share. "s" refers to how many months ahead we might be looking to see where the stock market's trailing year dividends per share are expected to be at that point in time. "Current" means now (or your period of interest) and "current - 12 months" indicates a value that was recorded 12 months earlier (or 1 month earlier, or 13 months earlier, as whatever the case may be.)
But "m", our amplification factor, is something we've empirically observed. Typically, or at least through much of the current century, we've found its value ranges between 6.0 to 12.0, and we most often select the mid-range value of 9.0 for use in forecasting where stock prices are headed.
But what affects the actual value of this amplification factor? We've previously observed that it can vary substantially, as this single component in our math absorbs what we describe as "noise" in the market, but what if it has its own fundamental component?
We ask that question today because we think we're on to something. The chart below, updated from the version we posted one month ago, shows the game that's afoot (the only changes are that we finalized the data point for September 2011 and added a new data point covering this point in time through October 2011):
(click to enlarge)
Right now, trailing year dividends per share for the S&P 500 are retracing the exact same levels they first recorded in the years from June 2003 through December 2007. But, stock prices aren't at the same level as they were during that period. They are instead about 14-16% below that earlier trajectory. ...MORE