"Cheap" valuations based on historical price/earnings ratios have kept many investors bullish on world equities over the past three years despite what now appears to be routine economic disappointment and seemingly shorter business and profit cycles.

But there is growing anxiety that temporary sentiment and stock price boosts related to central bank money printing and emergency lending bear little relation to the long-term profit outlook, among non-financial firms at least.

Even though 12-month forward price/earnings ratios for world equity look good value, periodic pops in prices have increasingly not been matched by rises in earnings projections which have started to move sideways.

As ever, either the price in this P/E ratio is indeed cheap or earnings projections need a reality check too and historic valuation averages are restored by a drop in the profit outlook.

Macroeconomic hopes hinge on a U.S. recovery gaining more traction, a soft landing of Chinese growth to about 7.5 percent from the double digits of the past decade and a resolution of euro zone's systemic sovereign debt and banking problems.

All three of these, however, were in doubt again in April and the anxiety knocked some 5 percent off MSCI's world equity index from their March peaks. That leaves stocks still up 8 percent on the year but, just like last year, the price momentum and direction seems to have stalled.

Even though bouts of central bank money-printing and cheap lending in the United States, Europe and elsewhere periodically offer a fillip, as the European Central Bank's money flood did again spectacularly in the first quarter, the effect on the real economy and market prices tends to fade fast.

In the event, the P of the PE ratio advances and retreats, but not the E - leaving bulls to state their case continuously on each pullback but pessimists to question the whole construct.

"Do people really think E would be as good without the massive QE (quantitative easing)around the world?" asked hedge fund manager Stephen Jen at SLJ Macro Partners.

SLICED AND DICED

Of course, there are many ways to dissect valuations and many regional and national comparisons.

For one thing, many investors are currently overweight U.S. equity on a belief that a steady if unspectacular recovery there contrasts to economic contraction and systemic problems in Europe and the slowdown in China and the emerging markets.

But, just as vastly superior growth in emerging markets last year did not stop their emerging equity universe significantly underperforming, questions of valuation and the best models to use have prompted some strategists to question a U.S. bias.

Richard Cookson, chief investment officer at Citi Private Bank, reckons the U.S. market may be cheap when comparing a forward P/E ratio of 12 with a trailing P/E of 15, but he said forward earnings are just a guess and take no account of whether you are at the top or bottom of the profits cycle.

"The problem with using either of these valuation metrics is that they're pretty rubbish as a guide to future returns," he said. "The consensus has completely failed to predict any fall in profits over the past 30 years."

Cookson said he prefers the U.S. Shiller P/E model that works like a moving average of the past 10 years of profits to iron out the cycle and combined with dividend yields works well as a guide to implied 10-year returns.

At 22.2, however, the Shiller P/E is pretty expensive compared with the average since 1950 of 18.7. And while this partly relates to impressive U.S. corporate margins, these margins - as measured by profits as a percentage of nominal gross national product - are already at record highs of over 7 percent.

As margins have a pretty strong tendency to revert to their average over time, this leaves U.S. stocks "dangerously exposed", Cookson said, adding that far cheaper equivalent European valuations at least pay investors for taking the greater systemic and growth risks there.

Citi's implied long-term equity return in core Europe at 11.8 percent, for example, is more than twice that in the U.S. at 4.6 percent. And it's hard to imagine a scenario where a full-scale euro meltdown - if that's what such low euro zone equities imply - would not send systemic shockwaves across the Atlantic too.

What's more, ThomsonReuters data shows that margin gains from cost-cutting in jobs, pay and other expenses was a significant part of the U.S. profit recovery since 2009 but that this route to bottom-line improvement is reaching its limits.

Only 41 of S&P500 firms releasing first quarter earnings this month are expected to report higher margins despite lower revenue, down from 86 in 2009. And 102 companies are expected to show lower earnings despite rising revenue, up from 54 in 2009.

The U.S. does not have to return to recession for investors to wonder where the extra juice for earnings growth is going to come from.

(Graphic by Scott Barber; Editing by Ruth Pitchford)

• A Permanent Economic Emergency