Posts filed under “Investing”
I get all sorts of email. Some of it, I simply do not know what to do with. I respond to polite requests, I look at suggested specific links. Some I simply delete.
Then there’s this sort of thing: I never know what to do with half formed concepts or unsupported arguments. These tend to raise more questions than they answer.
Consider the following interesting analysis (I responded to the author, but never heard back from them).
Based on this week’s Chart of the Day, this person concluded:
"Wall Street uses 12-month forward EPS estimates to calculate P/E ratios. The chart below is based on 12-month trailing EPS, which inflates the P/E ratio. Based on 12-month forward EPS, the post-WW II P/E ratio range for the S&P 500 Index has been 10x to 20x, excluding the 1970s nadir ~8x and the 1996-2000 bubble range of 20x to 26x.
Regardless of the EPS figure used, the chart’s message is clear: today’s P/E ratio is NOT excessive…based on 1980-2006 performance, it is about average with plenty of “head room” for P/E expansion.
Also, the “steep downtrend” between the dashed red & green parallel lines in chart below counts as five Elliott Waves down…followed by a turn UP. THAT is extremely BULLish !!! Suggests the potential for P/E ratio expansion for years to come…..that would fuel an incredible BULL market.
I find this sort of thing quite intriguing. The letter touches upon some fascinating points — issues I am very interested in. But it fails to esolve them satisfactorily. Indeed, it raises more questions than it answers.
Here’s the first dozen or so that popped into my head:
1. Why does a trailing P/E (price/actual earnings) "inflate the P/E ratio?" Isn’t genuine data — what the earnings actually were, rather than what they were forecast to be — more reliable than analyst consensus of earnings?
2. Do P/E ratios have any predictive power in forecasting the stock market’s subsequent returns? What is the basis for that belief? What specific P/E ratios have historically triggered a buy decision with a demonstrated ability of out-performance in the past?
3. The 1980-2006 period includes the longest bull market on record (1982-2000), thus skewing the P/E ratio upwards. How does the P/E look for full period 1950-2006 (inclusive of highs and lows)? What does the 1906-2006 range reveal? How about 1966-1982?
4. Why do you think the market was in a bubble from 1996-2000? Wouldn’t late 1999 to 2000 be a more accurate range for the tech bubble?
5. What is your basis for saying the dashed line is an Elliot 5 count? If it is, what is the historical forecasting record of using Elliot Wave 5 counts of P/Es as a buy indicator?
6. What has past P/E compression and expansion cycles looked like? Is this one similar or different to prior oscillations? Why?
7. "NOT excessive P/Es" (emailer’s phrase) — what are they? What does that mean for subsequent market performance? Are "NOT excessive" P/Es a sufficient basis for making an investment decision? Is additional confirmation needed for a buy or sell signal?
8. Forward P/Es are consensus opinions. How accurate have they been at major turning points (tops and bottoms)?
9. In 1999 and 2000, the S&P500 P/E ranged from 25-30; Why did it shoot up to 50 two years after the bubble popped?
10. Is this actually a trailing P/E? (The chart is silent on this)
11. The 1982 Bull Market began at a P/E of 7. Will the next Bull market start from a higher, lower or the same P/E? Why?
Does that change your view of the "headroom?
About this original email: The idea behind this exercise isn’t to say the the original emailer was wrong. For all we know, the author may be absolutely correct about their forecasted "Incredible Bull market."
But how can we tell? Lots of conclusions and unsupported assertions are built in – highly subjective – but there was no persuasive proof. These various questions point to that.
One of the reasons I have long been a fan of quantititative,
technical and cycle based analysis is the ability to make an objective
– rather than a subjective, squishy analysis. That’s been a big problem with much of what passes for pattern based technicals, too.
That’s also the reason I recommended David R. Aronson’s tome, Evidence-Based Technical Analysis.
I very much like the idea of applying a more rigorous scientific method
of statistical analysis in generating less subjective trading signals.
Fascinating interview With Richard Arvedlund, Founder, Cypress Capital Management, who is not particularly optimistic on the economy going forward:
WE CAN ALWAYS COUNT ON RICHARD ARVEDLUND to take a different tack. Independent and bold calls on the economy come easy to this longtime money manager, who’s seen it all in his 30-plus-year career. But his balanced investment approach, with a focus on high-yielding, big-cap stocks combined with some bets on bonds, helps his clients preserve their capital as much as build it. The founder of Wilmington, Del.-based Cypress Capital Management, which has $450 million in assets and is now a unit of WSFS Financial, is at his best in troubled times. Trouble, the way he sees it, is straight ahead.
Barron’s: It took a year, but the calls you made when we last spoke are looking pretty good now.
Arvedlund: Well, until midyear the economy was running much stronger than I had thought it would. However, a GDP [growth domestic product] slowdown has clearly begun. The GDP growth rate dropped to 1.6% in the third quarter from 2.6% in the prior quarter and 5.6% in the first quarter. We have not seen GDP growth below 2% for four or five years. We now have preconditions in place for a recession.
The preconditions would be the following: Whenever housing starts and permits drop by the rates of decline that have been exhibited — 10% to 20% — it has always preceded a recession. What is remarkably different in housing than just about any other sector of the economy is that whenever housing cycles turn down, and that’s happened twice in the last 30 years, once in the late ‘Seventies and once in the late ‘Eighties, the downturn tends to last much longer than people dream. The average cycle is three to four years.
Recession: The Stage Is Set
Interview With Richard Arvedlund, Founder, Cypress Capital Management
Barron’s, Monday, November 13, 2006