"We can calculate the historical errors of various valuation models in forecasting actual subsequent 7-10 year market returns. A good model should have random errors – that is, the errors should not themselves be highly predictable based on data that was readily available at the time. For the 'equity risk premium' models that Janet Yellen and Alan Greenspan often reference as evidence that stocks are not overvalued, it turns out that the errors of these models have a correlation of about 85% with profit margins that were observable at each point in time. In other words, these models make large and systematic errors because they fail to account for the cyclical variation of profit margins over time."
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