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Financial Physics
Financial Physics represents the interconnected
relationships among several key elements in the economy and the financial
markets that determine the stock market’s overall direction. This section
and its presentations will provide a highly provocative and insightful
perspective on the relationship of the economy ('the source of wealth') and
the equity markets ('the measure of equity wealth'). Whereas other sections
present analyses of historical data to provide perspectives, this section is
dedicated to exploring the fundamental factors and economic relationships
that drive trends and valuations in the financial markets.
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UPDATED THROUGH 2007
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Financial
Physics
This presentation introduces the core "Financial
Physics" model. The key factors include Real GDP,
Inflation, Nominal GDP, Earnings Per Share (EPS), and P/E Ratio.
Since Real GDP has been relatively constant over extended periods of
time and all other factors are driven by inflation, a primary driver of
the stock market is inflation—as it trends toward or away from price
stability. Given the current state of low inflation and the
likelihood of it either rising (inflation) or declining (deflation), P/E
ratios are expected to generally decline for a number of years. As
P/E ratios decline and EPS grows, the result will be another relatively
non-directional secular bear market.
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UPDATED THROUGH 2007
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Crestmont's
Research:
Putting It
Together
Guests and clients often ask for a succinct explanation
about how to tie together the various elements of research and
perspective that are presented within Crestmont's website. This executive summary represents an
initial draft toward explaining, through a series of steps, the
relationships of some of the research. Several of the charts
within this website are referenced.
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Dissecting
Returns
Financial Physics presents the interconnected
relationships between certain factors in the economy and the environment
in the financial markets. This analysis dissects the components of
Total Return and looks at the potential returns available for the rest
of the decade. Without further, unsustainable increases in
valuation (P/E ratios), returns will likely be less than the historical
average. If inflation remains below the historical average (near
3.5%), economic growth (GDP) and earnings growth (EPS) also will be
below historical average. Future returns from the stock market are
likely to be muted if (1) inflation remains stable and earnings grow
slowly or (2) if inflation increases and drives P/E ratios lower. Strong
stock market returns over the rest of the decade only can occur if P/Es
expand further against the laws of Financial Physics.
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