Getting to the Bottom of the Market
Mar 3rd, 2009 | By Andrew Gordon | Category: Financial News, Stock Market InvestingThe big comeback should already be here, according to Wall Street pundits. It was due to arrive in the fourth quarter… a 50 percent increase in earnings led by – of all sectors – banks.
Didn’t happen. The quaint notion that banks could beat their terrible earnings of fourth quarter 2007 by a mile was washed away in a tidal wave of bank writedowns in 2008.
Instead, earnings in the S&P 500 financial sector lost another 9,820 percent in the fourth quarter.
The lesson? When you think things can’t get worse, think again…
They can get a lot worse.
It may feel that the markets can’t get much worse. But of course they can.
In fact, I’m absolutely sure they’re far from hitting a bottom.
It’s true that P/E ratios (price-to-earnings ratios) look pretty cheap. The trailing 12-month P/E ratio for the S&P 500 is 13.7. The historical average is 16.
The forward S&P looks even cheaper. It’s at 11.9. But Wall Street has been awful in forecasting future earnings…
Forward P/E ratios are nothing more than a big guessing game.
Past earnings may not predict future ones, but at least they’re real. And earnings which are averaged out over the past 10 years do the best job of revealing a company’s true earning power.
That’s because a 10-year period covers at least a couple of business cycles. You won’t get single-year inflated earnings from a juiced-up economy. Nor would you get depressed earnings from an economy on the skids (like now).
On a ten-year earnings basis, P/Es are 13.4. That’s still pretty cheap. The historical average is 16.4. But, as you follow the blue line in the chart below, they can go much lower…
Since 1880 there have been five peaks and four troughs. And, as first discovered by Professor Shiller of Yale, they mirror the highs and lows of the U.S. stock market.
In 1982 the P/E fell to 6.6 before bouncing back up. The four lows have dropped to between five and nine.
At 13.38 right now, it would have to drop by another third to reach nine. It would reach five with a further 63 percent drop.
This time it’s different? I don’t think so. The markets have another major down leg to go.
Source: Getting to the Bottom of the Market
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Andrew is currently the Editor-in-Chief of two monthly investment research services INCOME and The Wealth Advantage. He has also become a leading expert in utilizing Exchange Traded Funds to profit from rising and falling market sectors.
