A long expansion is a persuasive argument for buying stocks even though forward price-to-earnings ratios are historically high. Investors are likely to be willing to pay more for stocks if they perceive the economic expansion could last, let's say, another four years rather than another two years. The more time we have before the next recession, the more time earnings can grow to justify currently high valuations.
If a recession is imminent, stocks should obviously be sold immediately, especially if they have historically high P/Es based on the erroneous assumption that the expansion's longevity will be well above average. Bull markets don't die of old age. They are killed by recessions.
Previously, I examined the Index of Coincident Economic Indicators for some historical guidance on the longevity of economic expansions. Let's update the analysis:
(1) It has taken 68 months -- from January 2008 through October 2013 -- for the CEI to fully recover from its severe decline during 2008 and early 2009. The previous five recovery periods averaged 26 months within a range of 19 to 33 months.
(2) The good news is that the average increase in the CEI following each of those recovery periods through the next peak was 18.6%, over an average period of 65 months within a range of 30 to 104 months. If we apply these averages to the current cycle, then the CEI would peak in 48 more months, during March 2019, with a substantial gain from here.
(3) For now, let's just enjoy the fact that the CEI is at a record high, and 4.1% above its previous cyclical high during January 2008. All four components of the CEI (payroll employment, real personal income less transfer payments, industrial production, and real manufacturing and trade sales) are at record highs.
Source: Ed Yardeni — Ed Yardeni is the president and chief investment strategist of Yardeni Research Inc., a provider of independent investment strategy and economics research for institutional investors.