Equity Valuations Based on Price to 10 Year Real Earnings

Is the equity market expensive, having run up so much since last March? Some people prefer a variation of the P/E multiple to measure the general cheapness or expensiveness of stocks by taking earnings from the last 10 years and adjusting them for inflation. By doing this, you get a much better sense of the long term earnings potential of S&P 500 companies and filter out the noise of short term writeoffs and unsustainable short term increases in earnings. And, you strip out inflationary growth in earnings, which nobobdy should pay for when investing.

So, here is a chart of the S&P 500 that shows the price of the index divided by the previous 10 years real (inflation-adjusted) earnings. The red line is the historical average.

From Greg Mankiw: