Kass: The Decline and Fall of P/E Multiples

This blog post originally appeared on RealMoney Silver on June 18 at 8:18 a.m. EDT.

In "Black Swans Return," I argued that the world is interconnected, interlinked and increasingly complex. Risks of black swans, previously perceived to be small by corporations, investors, politicians and regulators, are now being reassessed, owing to (among other issues) globalization, tighter correlations, advancements in technology, the growing/excessive complexities of interlocking supply chains and derivatives, the acceptance of greater/extreme risk-taking ("the longer people make money by taking risk, the more imprudent they become," the Minsky moment), the greater connectivity of increasingly more complex systems (see Paul Ormerod and Rich Colbaugh) and so forth.

I went on to opine that, given the "newness" of these and other challenges as well as the greater frequency of black swan events, P/E multiples are being pressured and should continue to contract as a comparison between today's valuations to those of history can be expected to lose some of its significance and relevance.

There exists numerous price/earning multiple deflators and non traditional headwinds to growth. These factors don't necessarily prevent an extended bull market, but they will most certainly deflate price/earnings multiples and put a cap on the market's upside potential:

• rising taxes;
• fiscal imbalances in federal, state and local governments;
• the absence of drivers to replace the prior cycle's strength in residential and nonresidential construction;
• the long tail of the last credit cycle (Greece, Portugal, Spain, etc.); and
• inept and partisan politics.

The last point, inept and partisan politics, was prominent in my mind yesterday as I watched the House Energy and Commerce Committee grill BP (BP) CEO Tony Hayward.

When I was growing up on Long Island in the 1950s and 1960s, there were three television stations (ABC, NBC and CBS); there was no CNBC, Bloomberg, HBO, CNN or C-Span.

During this period (40 years ago), Americans had the deepest respect for politicians, and by the time President John F. Kennedy was elected, you could say politicians were idolized, viewed with awe (at times) and put on a pedestal.

Our politicians were not that visible in days of old. Interviews in Life Magazine revealed their personal lives, but, like The Wizard of Oz, they remained very much behind a curtain of secrecy.

Of course, that was a half century ago.

In the interim interval, the three stations morphed into nearly 1,000, as cable television, satellite TV, the Internet and other influences changed the communication landscape. In the process, our politicians became much more visible. Congressional hearings were featured live on cable, and those politicians' strengths and weakness were slowly revealed.