SPX Earnings & Multiples ?
There’s an interesting article in today’s WSJ in which (coincidentally), I have a brief quote in:
"The financial system is undergoing a sea change that is forcing a global sell-down of assets. Even when this is complete, there is likely to be greater restraint when it comes to the use of borrowed money to juice returns. At the same time, investors are likely to demand a far higher price to take on risk than in the past. Even if financial stocks feel the brunt of these changes, few, if any, industries will be unaffected.
That argues for prices that reflect reduced expectations of future profits. Yet consensus estimates peg 2009 aggregate operating earnings for companies in the Standard & Poor’s 500-stock index at about $94 a share, according to Thomson Reuters. That figure assumes earnings growth both this year and next.
If those estimates panned out, the S&P on Friday would have traded at what looks like a bargain multiple of about 9.3 times forward earnings. Shift earnings to the lower end of the consensus range, about $75 a share, and the multiple rises to 11.7 times.
That still might seem cheap compared with multiples that often exceeded 20 times during the 1990s. But it is well above trough valuations of about eight times seen during the depths of the 1970s bear market, according to data from UBS. And the economic outlook, along with the unwinding of the credit bubble, means it is unlikely that earnings will increase this year or next. The better question is how far they will fall.
Bears are well below the consensus in their answer. Barry Ritholtz, director of research at Fusion IQ, for example, says he reckons that 2009 earnings could drop to about $50 a share. In that case, even a multiple of 14 times would bring the S&P to about 750 — nearly 15% below current levels."
Good stuff . . .
Source:
Autumn Is Here. Now for the Fall…
DAVID REILLY
WSJ, OCTOBER 25, 2008
http://online.wsj.com/article/SB122488013725867611.html
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October 25th, 2008 at 12:18 pm
Barry,
If you feel the market is 15% overvalued, then why have you turned bullish recently? I do see that the market is trading at a historic low price to book. Granted, “book” may be as questionable as the earnings.
Are you buying dips despite valuation?
October 25th, 2008 at 12:18 pm
Barry:
Just noticed this posted by Hussman on Thursday. Won’t quote the whole thing, but here’s the part not just related to the fund. The stats at the end about P/E are interesting. Of course I have no independent verification, but Hussman, et al, are good with nerd stuff like that:
“While we allow for further market weakness, investors should also allow for a potential market rally in the 20-25% range (toward 1100 on the S&P 500). Even in 1973-74, the S&P 500 halted its decline at 48%. In 1929, the initial decline also halted at 48% (followed by an advance of nearly 50% over the next 6 months before weakening again). Even if this bear market is headed toward a P/E of 7, a single decline, uncorrected by a major rally, is unlikely. Bill Hester also observes that historical bear markets ending at single-digit price/peak-earnings multiples also generally started at multiples about 10 or less (with the exception of 1973-74 when earnings actually grew to new highs as stocks fell). We can’t rule out further weakness of perhaps 10-12% in the major indices but do not anticipate it.”
October 25th, 2008 at 12:20 pm
Ken Fisher was on Fox yesterday saying how cheap stocks were not so much based on earnings multiples, but relative to long-term interest rates (something he’s been saying since S&P 1500). Three points: First, I don’t recall him saying clearly what he thought earnings on the S&P 500 would be this year or next. That’s telling. Second, Howard Simons has mentioned several times the problems caused by comparing earnings yields to Treasury rates when the latter is considered a *refuge* from the former, not simply an alternative. Third, the most glaring shortcoming of Fisher’s commentary over the past 12 months has been an examination of why he’s been so wrong. Specifically, he believed that a housing collapse couldn’t happen because too many people were already worried about it. Given that the theory underlying so much of his investing (“they are worried, so I don’t have to be”) has been shattered, it seriously calls into question the foundations of his whole approach. (By the way, I think Fisher is guilty of a lot of the same things as Greenspan. They both trusted “self-interested” capitalist CEOs far too much, i.e. “You don’t need to regulate. You don’t need to worry about it so much. These hard-nosed businessmen will take care of it in the marketplace.”)
October 25th, 2008 at 12:31 pm
And if my information is correct a multiple of 14-16 times is the Historical Average. In bear Markets (think 73-74, 00-02) multiples can drop to the single digits (7-9)…
I think 50-60 dollars a share Trailing 12 months (or reported actual earnings) is probably a good estimate.
However, that gives the S&P 500 another Sizable Haircut…
See links here:
http://comstockfunds.com/files/NLPP00000%5C293.pdf
and here: (scroll to bottom and click this link: S&P 500 Historical Average Price to Earnings Ratio):
http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,5,0,0,0,0,0.html
October 25th, 2008 at 12:42 pm
It is my understanding that cash currently on the sideline is worth about 50% of the S&P 500 market cap. This is several standard deviations from even past lows. I wonder how much HF liquidation is left to go. Any thoughts on this Barry?
October 25th, 2008 at 12:43 pm
“Barry,
If you feel the market is 15% overvalued, then why have you turned bullish recently? I do see that the market is trading at a historic low price to book. Granted, “book” may be as questionable as the earnings.
Are you buying dips despite valuation?”
I’m wondering the same thing?
October 25th, 2008 at 12:44 pm
Wait, I’m missing something here.
Aren’t stocks valued based on discounted future earnings, regardless of time frame? So, if earnings went away completely for the next two years (but expectation was to return) stocks would not take a 100% haircut, would they? If this is the case then I don’t see the linear relationship between PE multiple and stock valuation.
October 25th, 2008 at 1:01 pm
There are numerous stocks trading at very healthy valuations, many of the mining and energy stocks are notable in this regard, however that is because they’re still reporting record earnings, those are likely to drop going forward. But at PEs of 4-6 on many large players – teck cominco was down 15% in pre market yesterday which I took advantage of after being down continusouly in previous days and having just reported fantastic earnings. Ganett is trading at at a ridiculous level regardless of how much you think newspapers are obsolete, and yes they’re still making money to pay that fat dividend. There is lots of value trading at 4-7 time earnings, solid companies, low debt, and selling things that people need. Healthcare may be a bubble but sny and gsk are reasonably valued at these levels with nice dividends while you wait it out. Even carnival cruise lines is getting to nice evaluation levels. There are utilities trading at 7 times earnings with power purchase agreements into 2020. Nasdaq is another story but even msft reaching reasonable valuations for a tech stock.
October 25th, 2008 at 1:09 pm
It may still be overvalued in relation to current earnings/book/dividends, that doesn’t take away from its potential future value.
It also doesn’t take away from the potential of a rather severe sudden rally, which would be a great trade.
October 25th, 2008 at 1:11 pm
Those who are asking why Barry is short term bullish should read the excerpt from Hussman. I’m sure Barry has more sophisticated reasons than that, but you may get an idea.
October 25th, 2008 at 1:12 pm
ss @ 12:18:07 PM
Not necessarily a contradiction.
As is so often the case, it all depends on one’s time frame.
October 25th, 2008 at 1:16 pm
OOps.. My Bad. P/E ratios Did Not get down to the single digits in the 00-02 Bear Market. They stayed Elevated– in the upper teens to near 20.
Heres a (rather Rough) chart of the 1929 crash Mike in Nola was discussing above in regard to Hussman and the likli-hood of an upcoming Retracement:
http://www.lowrisk.com/crash/1929crash3.htm
Notwithstanding Barry’s 10+ good points a week or so ago about why we may be in for a Trading Bounce/Bottom I think the Historical Perspective of the 1929 Bear Market, the 73-74 Bear Market, and the 2000-2002 Bear Market is that they all took Well Over 12 months to Form ‘The Bottom’– Giving Investors/Traders Plenty of Time to get in. Given the sheer Magnitude of the Problems/Issues Responsible for this Bear Market (12 or so months now from the Market Peak in Oct. ’07), the fact that the Stock Markets and Real Estate Markets are directly linked, the fact that (on a Historical Basis) it has taken anywhere from 3-5 years for prior Housing Recessions to form a Bottom, it is anyone’s guess (outside of advertising and ratings) why some of these Pundits on CNBS, Bloomberg, et al. continue to Harp about ‘The Bottom’ being near.
And Notwithstanding my prior post above The question I have with some of todays commonly used indicators such as the VIX, Put Call Ratio(s), etc. is that we are now trying to apply them to Markets that are linked Globally (linked in large part by the Credit Derivatives Market–some 60+ Trillion Dollars worth).
I don’t know that many of these technical indicators and data points hold the water they once did…
However, if some of the Fans of Elliot Wave Analysis are out there (Andy Taboo) it would be interesting to see where we are with that. If I recall some Folks were looking for one more Hard Push to the Downside… before we get a Relief Rally.
October 25th, 2008 at 1:23 pm
This graph is illustrative (S&P vs S&P P/E)
http://tal.marketgauge.com/dvMGPro/charts/Charts.asp?chart=PERATI
it would be nicer if it went back further but historically it still shows the s&p as expensive. Nevertheless it also shows that that the s&p p/e was not a determiner of the 2003-2007 rally. People mention that the 70s held lower market P/Es – it also held higher interest rates. Barry likes indexes, I prefer individual stocks because then I can weed out the crap, the only banks I’d buy are the cdn banks and USB with TD being my top cdn choice, when I buy the index I have to buy all the other crap in there. A lot of the income trusts hit very nice levels, some are also too small for any fund to invest in but for small fries you can get involved – tjere are advantages to being a retail investor.
October 25th, 2008 at 1:35 pm
pro/con, buy/sell, Bull/Bear, that’s all fine, but noone is discussing ‘Currency Risk’…
that’s, hardly, a “Black Swan”, either..
all this talk of E, in P/E, or E, in A=L+E, and noone cares to wonder whether tomorrow’s E will be = to today’s E?
curious..
October 25th, 2008 at 1:40 pm
I have enjoyed reading this blog for some time but have not joined in because I feel very much less qualified than the regular contributors. However, because this issue is THE issue for both traders and investors I hesistantly offer what little I have gained from 37 years trading the markets. I trust you all will correct my errors.
1) multiples are primarily a function of (a) long term interest rates and (b) expected earnings growth. In my view, earnings growth will be weak for a number of years; and, if the world doesn’t end, then interest rates will begin to rise (possibly significantly) within the next year. Therefore, multiples will remain relatively low.
2) S&P companies likely to have high relaive earnings (e.g., Exxon, Microsoft and so on) have had relatively low multiples even in the last bull market. So it is not total S&P earnings that matter to me but the distribution of earnings. If Barry is right about $50 S&P earnings, how many companies will account for, say, 50% of that total and are they growth companies?
3) Whatever the market low will be — it will not come before mid 2009 — it will lead on to fairly desultory trading range market. I am interested in trying to “guesstimate” that trading range. Picking a low is folly.
4) Who will be the buyers? For all the commentary about hedge funds and mutual funds as the determinative, marginal buyer and seller, the dominant buyers over the past 25 years have been corporations and retirement funds. My view of the future does not include continuation of large-scale, corporate share buy-backs or M&A activity. Secondly, even if retirement funds are not eviscerated by this bear market, they face a long-term future of payouts to retirees dominating cash infusions. good luck.
October 25th, 2008 at 1:42 pm
BR: Are you referring to the operating earnings that David Reilly is referencing in the article or to reported earnings? My guess would be the latter, but if not, could you clarify? [Chart for reference here with S&P's recorded and projected earnings data for both.]
Quick aside: Regarding the possibility of a bottom forming in the S&P 500, isn’t it funny how we can both get to the same place using such different methodologies? [Link is to David Templeton who links to both of us!]
October 25th, 2008 at 1:45 pm
Just b/c Barry is bullish here, doesn’t mean he believes this is “the” bottom. It is turning into a great trading entry point, regardless of a person’s long-term view point.
I really don’t get how people can’t understand a short and long term view… It’s really not that hard of a concept
October 25th, 2008 at 1:46 pm
Among the deflationist websites I often hear energy stocks mentioned as a place with value. Even the deflationist Mish, sights energy as one of the few areas that doesn’t have rampant oversupply.
In considering these companies one needs to consider the price of oil relative to the increase in the USD. From my perspective as a canadian, the CADUSD was around parity in July when oil was at around 140, now the CADUSD is at .785 and oil is at 65, but for a candian oil company oil that’s the same as 82 bucks with the dollar at parity, they can still make a killing at those levels, and I’m talking traditional not expensive oil sand plays.
When the dollar heads south again it will support the price of oil, same thing happening with gold. In these respects the fall in oil is not as much as everyone says it is, likewise for gold, that is if at least if you’re not living in the US but you got all kinds of things the US needs. Heck if I was american and I was stepping in long I’d be taking advantage of the strong USD and stepping into select cdn companies who have gotten trashed, the usd may have room to go but we at some point our resources, budget surpluses, conservative banks and federal minority governments (meaning that nothing gets done – eg no gov’t meddling) will count for something.
October 25th, 2008 at 1:48 pm
One does not make investment decisions in a vacuum. All assets are owned on a relative basis to other assets. Currently, the ten year treasury yields under 4%. Multiples on stocks could contract to 7-10 range but how likely is that with an alternative of 4%?
If treasury yields rise substantially, multiples will probably contract further. At these levels, it is not likely.
Stocks and other riskier assets like corporate bonds are worth the risk at these levels.
October 25th, 2008 at 2:00 pm
It is my understanding that cash currently on the sideline is worth about 50% of the S&P 500 market cap. This is several standard deviations from even past lows. I wonder how much HF liquidation is left to go. Any thoughts on this Barry?
—————————–
Wait until governments around the world start issuing more bonds for all the promises they’ve been making. Bond yields will soar and money will be flowing into those, not stocks!
October 25th, 2008 at 2:12 pm
http://www.telegraph.co.uk/finance/3248452/Calpers-suffers-50bn-fall-in-pension-fund-assets.html
Are pensions pulling out of hedge funds? Is this what is causing the spike in the dollar and the fall of foreign equities and currencies as hedge funds liquidate assets to pay off bailing investors?
If so, where does that money go once it is out?
October 25th, 2008 at 2:16 pm
Here’s a nice post from Barry in Jan,2006.
Thanks again BR for all you do! This site has been invaluable to me.
Once again, it’s all about sentiment which I don’t see turning around anytime soon. This will hold P/E’s at the low end.
P/E Expansion and Contraction
Monday, January 02, 2006 | 11:37 AM
in Investing | Markets | Psychology/Sentiment
Last week, I showed a 50 year chart of the S&P500, focusing on the P/E over that time period. Today’s chart covers the same issue, only we focus on the 1982-2000 Bull market.
Some people argue that P/E expansion wasn’t all that significant; they say it was (if anything) a function of falling interest rates. In my mind, that only partially explains why multiples expand; It certainly cannot rationalize why P/Es went from 7 to nearly 50 over the course of ~20 years.
Why might the median P/E have run from 7 to 32 during the Bull market?
My explanation is Psychology: something shifted in investor sentiment that made them willing to pay more than $7 for a $1 of earnings — much more. That change is best explained by a sentiment shift related to perceived relative Value.
>
Most investors do not think P/E expansion as the lion’s share of the market’s 82-2000 gains; Instead, they credit a robust economy, technological advances, productivity gains, and (of course!) earnings improvement.
And all those elements did have an obvious impact — by my math, they were responsible for about 25% of the performance.
But the biggest contribution these four elements had was not to the bottom line; rather, it was to investor psyches that gradually became willing to spend more per dollar of earnings than they had been. They allowed a rationalization of higher prices: Aren’t stocks worth more if the economy is doing well? Doesn’t technology make companies more efficient with their capital? If workers are more productive, went the thinking, than earnings will be all the more better.
Notice how squishy these thoughts are; they may be rational, but they are hardly the sort of easily quantifiable data points that makes for a dispassionate, calculating investor.
Link including the graph:
http://bigpicture.typepad.com/comments/2006/01/pe_expansion_an.html
October 25th, 2008 at 2:18 pm
The market has not priced in that there will be no market as we know it. It’s way worse than the 70′s. Maybe even the 30′s.
Unlike anytime in history, we now have more banks, companies, and whole insolvent sectors of the economy now directly propped up by the government. And indirectly, the market itself. That always ends up well.
You can’t even say the market has priced in the full effect of a deep U or L shaped recession not seen since the Depression. The whole world knew those earnings last week would stink, but apparently the market reaction was the equivalent of shocked surprise. What’s next?
The idea of stocks as a retirement vehicle is being completely undone. There is a cultural change in this regard that is happening after the worst losses of “wealth” in history. The market has not even begun to price in that the pool of buyers and demand is going to be a mere fraction of what it was.
We have, for the first time in history, the possibility of not funding our national debt, which approaching 100% of GDP (not since WWII)– except through printing. So to add a cherry on top, the intrinsic premium of US stocks valued in the world’s reserve currency is drawing to a close.
A lot of historical firsts into uncharted waters. I’d say a stock price equals sentimental value plus the present value of all expected dividends. Dividends in the next 3-5 years you say….?
October 25th, 2008 at 2:27 pm
I obviously can’t speak for BR, but you people wondering how BR can both buy and make such a comment to the media seem to be really missing the point. BR didn’t go in whole hog; he didn’t draw a line in the sand. He reasoned that we’ve reached the point where an investor **PROBABLY** won’t get burned too badly with an entry at S&P 900s. But at the same time, we could go a fair bit lower. Scaling in? Ever hear of it?
October 25th, 2008 at 2:32 pm
For all the commentary about hedge funds and mutual funds as the determinative, marginal buyer and seller, the dominant buyers over the past 25 years have been corporations and retirement funds. My view of the future does not include continuation of large-scale, corporate share buy-backs or M&A activity. Secondly, even if retirement funds are not eviscerated by this bear market, they face a long-term future of payouts to retirees dominating cash infusions. good luck.
————————
Another way of looking at stock prices is to add up all future discounted cash flows. Of course the price will be very different if you discount using a risk free rate of 3.5% or 6%.
Using my assumptions, stocks have been overvalued for a very long time.
Then you could argue about the liquidity premium, blah, blah blah… I could just argue that half the market is not calculating anything. These investors say to themselves: “Wow, I like Google, everybody loves Google. Google is a good business so Google has to go up. It’s all about supply and demand and demand is strong!”
On this basis, I would argue that a significant % of this liquidity premium in multiples comes from all these investors who do not sit down and do the math. And these investors have penalized even the pros. Why? Because the pros who’ve done the numbers know the multiples are too high but they still have to be fully invested, so they’ve resorted to comparing one stock vs.the other even if fundamentally the whole market is too expensive.
You try explaining that to the average Joe who’s been forced to take care of his own portfolio because his company has canned the DB and converted to DC. Yup, we’ve forced average Joes to plan for their retirement without any formal education in financial markets. That is deplorable.
So now who will be the future buyers now that people will be paying down debt, never mind investing. As the economy slows and jobs are lost, many more investors will be forced to raid they pension accounts before admitting defeat.
If that was not enough, you’re going to start getting Boomers retiring and selling their investments to pay for their retirement. In Canada, most RRSPs (401K equivalent?) are emptied within the first few years of retirmenet. And for every retiring Boomer who takes out 20K, you need 4 Gen-X saving 5K. Good luck because even in the good years, the average contribution was something like 3K.
So you won’t be seeing much new money hit the markets, there is a lot of money on the sidelines but a huge chunk of it won’t be going into stocks.
My guess is that a lot of that money will be taken out to buy bread over the next couple of years but investors don’t know it yet.
October 25th, 2008 at 2:52 pm
14*50 = 750 ??
Strange math !
But the relationship between PE’s and market lows is not linear. In fact PE’s are often high in troughs, as earnings are low. Markets generally look at the future and not just one year.
If long term earnings recover somewhere on a path towards 70-75 over 2-5 years, then the market is fairly valued today.
If it is the great depression, the dow will drop towards 5000.
October 25th, 2008 at 3:34 pm
Favor to ask of the community: Can anyone create a graph showing the historical S&P for D/E ratio versus P/E multiples? Thanks!
October 25th, 2008 at 3:43 pm
For example
Here are some stocks that if you went back to 1992 you wouldn’t have seen a lower avg annual PE, in these respects these stocks can be viewed reasonably as cheap – that’s the point valuations for some companies have blown way way past 2003 and far beyond. Since most people buy stocks for them to go up this may be irrelevant, but there are big old buinsesses on the cheap. I’m not saying you should buy these, but it serves to illustrate a range of large companies who won’t be going away any time soon that are trading at 16 year low valuations and all reporting reaonsble earnings.
PFE 10 – drugs
HMC 6 – auto
TOT 5 – energy
msft 11 – software
tck 3 – mining
gci 4 – publishing
yes pfe has pipeline issues, hmc is selling things people say they don’t want, oil is going down, microsoft makes crappy software, commodities are dropping and no one reads newspapers but admist all that these companies will likely still make money.
October 25th, 2008 at 3:45 pm
Reply to geert
Consistent with my comments above, I do not believe in any way that it will take “great depression” to get to 5000. My expectation for the past many years is that the market would retrace the nonsense inspired by Greenspan in the 1990s and would retrace to at least the levels of his “excessive exuberance” speech of early 1996. Quite apart from depressions or any other mania, a retracement of a monetary-induced bubble would take us back to the DOW 4000-5000 level. I remember 1996 and it was not the end of the world.
October 25th, 2008 at 4:00 pm
People keep asking where will the money come from.
No one wants to invest in a falling stock market :-) However, the moment the sentiment changes and the stock market reverses suddenly *everyone* wants to be in the stock market. There is also the fundamental value of investing in a business that is making money (assuming for a second that the stock you’re buying actually captures a portion of that value).
Can anyone imagine an economy where there are no companies and people only invest in government bonds? Everything is controlled by the government and no private businesses? I don’t think that model works too well.
So I’d say this is not the end of the world as we know it. Will things change? Sure. Where’s the bottom? I don’t know…
October 25th, 2008 at 5:16 pm
The multiples in the 70s were for an inflationary scenario …
Given the deflation ahead multiples should settle out a liitle higher … but the question remains … What are earnings ?
October 25th, 2008 at 5:25 pm
It would seem that the earnings are less relevant than “What multiple are people prepared to pay for the earnings?”.
October 25th, 2008 at 5:26 pm
Three main things are different now then when we saw single digit P/E lows:
1) LT rates are lower, but as someone said, mainly because treasuries are a refuge. This could help stocks bottom at a higher P/E. the next 2 factors may lower the P/E.
2) As I like to point out, short interest was a) banned on financials for awhile and b) non-existent on Nasdaq. You will not see the sharp relief rallies of the past, but more like one-day wonders (a la the 936 point rise).
3) Most importantly, we are in a global environment now. The surging dollar has created a major problem for companies with a lot of foreign revenue. For example, last 4Q (the most important qtr) a lower dollar added 500 bps to foreign revenue over 2006. This yr, based on where the dollar is now, we will have to subtract roughly 1300 bps, 13%, compared to 07. This will make earnings growth (think Google, Amazon, Yahoo, ebay) hit a brick wall. These companies also don’t benefit from a stronger dollar lowering commodity input costs…Google does not manufacture anything.
Also being in a global environment, we really need a “global synchronized bottom” for all markets to rebound. If US markets start to recover, but the others continue to be hammered, our recovery will be snuffed. The current monetary regime is woefully inadequate in a global marketplace. I am working on a short treatise on this which I can post soon.
October 25th, 2008 at 5:27 pm
An other way of looking at it is using PE based on past peak earnings.
S&P 500 12 months trailing earnings peaked in June 07 at 84 (ca 30% of which were financials’ earnings)
On that measure the S&P trades slightly above 10x, while the low was slightly below 7x back in March 1980. (Would imply S&P of 600!!!). But interest rates were then much higher leading to lower multiples.
10x peak earnings is among the lowest valuation since the bull market started in 82.
12m trailing earnings are now close to 50. They bottomed at ca 23 in the 00-02 bear market but the S&P level is already very close to 02 level.
Ie either massive drop in earnings will occur or the market is cheap.
How much lower can S&P earnings go?
Financials recover to 1/4 of peak levels (=9) and the rest drop 30% from the current 50 for a total of ca 44 in 2009. Plausible?
October 25th, 2008 at 5:34 pm
Agree with DANM @ 2:32:05 PM.
You notice a lot of talk about “forced selling” implying that (hedge)funds wouldn’t be selling if they weren’t forced to do so. Bull markets and Bear markets are mirror images of each other, so consider the example DANM provided of Joe the Plumber buying Google. That type of buying in addition to artificial lower rates (f*** you G’span) caused “forced buying” over many years. Cash was trash and anyone who hoped to invest was forced to pay huge premiums in the stock market.
All we are seeing right now is a return to normalcy. Of course it is depressing but that is because you are comparing an artificially pumped up market to a market that is returning to saner valuations. Forced selling is the mirror image of forced buying.
Joe the Plumber and his buddy Joe Sixpack are now shocked because they never asked the question What am I getting in return for my investment? They blindly threw money at Wall Street faithfully believing that they will get a risk free return rate of at least 8% in the long term. That is not an unreasonable assumption to make, but that assumption is only valid if you are buying at a reasonable price. In the last few couple of decades everyone drank the 8%+ per year forever koolaid and drove up prices too high to a point where it is hard to sustain high annual returns. Hence this return to a saner valuation level.
October 25th, 2008 at 5:44 pm
1. For anyone who is interested, Robert Shiller makes available on his website amazing data going back more than a century in re S&P 500 earnings, valuations, etc.
2. I have stared at his data until I am almost blind. Here are my conclusions:
a. the average PE ratio is approx. 15-16x.
b. average CAGR of the S&P 500 is closer to 7% than the 10% some people throw around.
c. the only way out of this mess is for corporate earnings to trend upwards. The only way for that is for U.S. corporations to create value. If they do, multiples should trend higher. If not, then lower.
d. Right now, P/E ratio based on a 10 Yr. moving average of earnings is 14x (slightly undervalued relative to historical norms).
October 25th, 2008 at 5:50 pm
Just thought of something else…lower LT rates may not result in higher P/E this time around. The proper discount rate is the weighted average cost of capital (WACC). The LT rate, or riskfree rate, is a component of WACC, but NOT THE ONLY ONE. The cost of debt, which now is astronomical due to record credit spreads, and cost of equity, rising due to higher betas, are crucial as well.
October 25th, 2008 at 6:06 pm
@Adam
“. Right now, P/E ratio based on a 10 Yr. moving average of earnings is 14x (slightly undervalued relative to historical norms).”
What about growth or dividends. Aren’t these traditionally functions of a stock value? I do not see these going up in the near term.
October 25th, 2008 at 7:14 pm
I think Chris in Canada is on to something. Right now my esteemed fellow posters here are all on a huge macro trip about the “markets”. Frankly I dont believe anyone has the informational resources to know the outcome of the current situation. BR, being a pro is starting to scale into the percentage play. Jeremy Grantham, running a couple of billion dollars and short the pound is doing the same. Many of you may be trading index products and etf’s and so you are focused on the “market” or a sector, and if you are quick enough there is plenty of trouble to go around. At the same time Barry and Chris are setting up for the inevitable, and right now their risk reward appears to be at a potentially historic and favorable juncture.
October 25th, 2008 at 7:24 pm
It would seem that the earnings are less relevant than “What multiple are people prepared to pay for the earnings?”.
Posted by: DP
~~~
Multiples are based on inflation … the higher the inflation the lower the multiple …
Everything I read and see now is a cloud around earnings.
October 25th, 2008 at 7:26 pm
re: lowered earnings
But when you compare it to interest rates that investors can get, it doesn’t sound so bad.
Anyway, you should always be very selective buying in a down market.
October 25th, 2008 at 7:32 pm
catman: those of us talking about the “markets” are making big picture observations. We perfectly understand that there are trading opportunities, sometime lasting years. There are no right or wrong opinions about the “markets.” There are only buy and sell transactions and the profit/loss you realize for a transaction.