On Friday, one respite, what about the so-called rule of twenty and what about the so-called suffering index? Perhaps the most important thing is that the rules have their limits.
The following figure shows the sum of inflation and PE, i.e. the ratio of share price to earnings per share. The rule of twenty was created so that, according to historical observations, this sum should be the first twenty. We would derive some clear standard from the graph that began in the late nineties, but between 2000 and 2019 we average around twenty:
Source: Twitter
If we were to take twenty as a bullion coin, valuations would now have to fall by about 4 percentage points to get to n. Otherwise, the PE would have to be 15 instead of about 19. Or there would have to be a rapid drop in inflation, which is a very likely option that is currently on the market. By the way, I wrote about the pros and cons of another rate hike, which is known as the pros and cons of the relatively rapid decline in inflation.
In my opinion, the methodological weakness of the rule of twenty is mainly deflation. Let’s take an extreme example: The economy falls into demand deflation, prices fall by 2% a year, economic activity freezes. In such a case, the rule of twenty would imply a PE of 22. Thus, the valuation can only be achieved in an environment for shares worth one fifth. The so-called index of (economic) suffering suffers from the same methodological weakness, its development is shown by a daily graph. It is a simple sum of inflation and unemployment rates:
Source: Twitter
The wall of inflation and unemployment has its simple logic in that you are poor, the more economically you are in general. The graph in this logic shows the gold of fifty and eleven years and a return to them in the kind of halves of the previous decades. However, even this indicator is not designed for deflation associated with the cooling of economic activity. In the above case, the index suffered by 2% deflation and 10% unemployment would come out to 8. The same as with 2% inflation and 6% unemployment. From the point of view of piety, however, these are certainly not equivalents.
If we wanted to enter the world of finance fiction, we could create a concept between them both, because they both have the same (percentage) point of unemployment, inflation and valuation action. Outside of the world of fi-fi, I would consider it as a break to enter the world of economics and the market. And one main note is that some rules and indicators can work for a relatively long time in certain environments and settings. But beyond these limits fall apart. Or are all the rules like that?
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2023-07-14 15:38:00
#rule #twenty #suffering #index
