The refusal by ordinary investors to buy stocks is even more surprising when you consider how little they're making from the alternatives. Their favorite assets of refuge— CDs, money market funds and U.S. government debt — don't even throw off enough interest income to compensate for inflation.
If stocks do return to a more normal 16 times profits, they're not likely to hover there for long. They tend to trade at widely varying multiples. Since World War II, stocks have traded as low as six times earnings and as high as 47.
What's more, stocks can stay at seemingly cheap or expensive multiples for long stretches. For the three years during the boom in dot-com stocks in the late 1990s, stocks in the S&P 500 traded at an average 37 times their previous year's profits. In the 10 years through 1951, they rarely broke 10.
At today's earnings, a 37 multiple would put the Dow at more than 36,000, according to FactSet. A multiple of 10 would sink the average to about 9,800.
All these hypotheticals can mislead, of course. To judge whether stocks are cheap or expensive, experts say you need to look at many figures, not just last year's earnings.
Some also like to look at an average of earnings over the past 10 years to iron out the peaks and valleys in business cycles. By this measure, stocks are trading at 22 times earnings compared with a historical average of 16. In other words, stocks may be too expensive.
One school of thought holds that multiples of all kinds should be lower now because the U.S. has entered a period of slow economic growth and lower profits as governments and households pay off their enormous debts. Bill Gross, co-founder of the giant investment company Pimco, calls this a "new normal."
Even if you don't believe Gross is correct, perception could become reality. If enough people refuse to buy stocks because they don't think prices will rise much, they won't rise much.
Harvey Rowen, the chief investment officer for Starmont Asset Management, says he's seen this self-fulfilling attitude among his clients. He says the clients who are calling want him to move more of their holdings into cash, or maybe gold.
"Nobody calls up to say, "Buy equities," he says.
Copyright 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.