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The paradox of the 19,000 Dow will undoubtedly be puzzling gold bugs who see the market as highly frothy at these PE ratios of over 19. Apparently the market has only heen here twice before and both times have been signals for a major crash.
So why hasn't/isn't the Dow crashing?
Why is a PE of 19 not a major warning of an imminent crash this time?
I think the answer lies in the interest rate environment we're in. At the current rates of interest a PE ratio of 19 isn't expensive but paradoxically cheap.
If someone invests 100k in fixed income in a normal environment and gets an annual 7k yield for example; in today's situation they'd have to invest perhaps 300k to get the same yield.
So in the past market where 100k might have got 7k in dividends, today the price of those same shares yielding the same dividend will be driven up to 300k to be in line with fixed income (yield).
So the past PE ratio of 6-12 or whatever for the industry is not the right measure. In today's market the PE ratio could easily be 18-24 or higher in order to match fixed income.
In this light it's not surprising that the Dow is 19,000 now even with a PE of 19+. The interest rate is what will undo the market ultimately.
