There is a school of investment thought which holds that you buy a stock when its earnings growth is higher than its price-earnings ratio and sell it when its earnings growth is lower.
If the growth of earnings per share, for instance, is 20 per cent and the share price is 10 times those earnings then the stock is a screaming buy. If the reverse, then sell the stock.
It's an appealing idea in its simplicity. It also does not work very well.
Almost every study done on it shows that there is only a very loose correlation between earnings growth and PE ratios, if there is any at all.
But enough people subscribe to it to make the US stock market appear vulnerable at the moment. Earnings growth in the US is sliding and is at best only in low single digits. Meanwhile, the PE ratio of the US market is in the mid-20s.
Surely there is a bubble here that must burst soon, the pessimists argue.
Good times cannot last forever in the US, and already there are warning signs in several areas of the US economy.