Regarding the dispute between bears and bulls over PE10 theory, the bulls claim that the CPA industry became too strict since 1990 and tightened the rules thus allegedly creating artificially low income for corporations and thus they alleged that the PE ratio is not too high. While it is true that some CPA standards have tightened in the past two decades the counter-argument to that is that since about 1990 corporate boards have aggressively implemented lucrative employee stock option programs that gave top management enormous windfalls, sometimes hundreds of millions of dollar in bonuses, if they made the stock price go up. This incentive made management get too aggressive and have too much incentive to implement aggressive accounting entries that
In recent years critics have tried to dispute the Shiller PE10 theory by claiming that corporate earnings in recent years have been made unfairly low because of an increase in overly strict rules imposed by CPA auditors. The theory is that one time wrote offs charged off during a recession shouldn’t be counted as a form of reduced earnings and the bullish advisors believe if these write-offs were not counted then earnings would be higher and PE ratios lower and thus stocks more reasonably priced. The problem with not counting charge offs of bad business projects is that when these projects were new they were viewed as profitable long term projects and their profits were used to calculate corporate earnings.
Many investors have been unduly influenced by the increase in stocks over the past 20 years and have a deep loyalty to the idea of buying on the dip and the idea if something goes wrong they will get a bailout. They should remember that even if the next recession is a light one that stocks can still fall simply because they are overpriced. There are three different overlapping criteria influencing stock values: GDP growth, corporate profit growth and PE multiples. If PE multiples are way too high (as they now are) then stocks could come down even if corporate profits and GDP growth are adequate. This is why a mild recession could make stocks go down by a much