There is a fairly simple relationship in long-term investing - the lower price you pay for an asset, the higher your expected return. The lower the price/earnings ratio of the market, the higher the long-term return from stocks.

From Greg Mankiw.

I think the forecast - the gray dot in the middle of the graph - is too low, at least relative to normalized earnings, which I define as sales per share multiplied by a normalized profit margin of 7%. With the S&P 500 at 806 and sales per share at roughly $1000, that gets me to earnings of $70 per share, and thus a normalized PE ratio of 11.5x.

Thus, the expected capital gain is about 8%. Dividends are $30 a share, so tack on a dividend yield of 3.7% and your expected return from stocks is nearly 12%, the highest in a long, long time.

I am a buyer of stocks here and will continue to scale in as the market goes lower.

I'm scared of the R-squared on this one.

Posted by: psychodave | November 20, 2008 at 08:48 AM