After All That, Stock Market Finally At Fair Value
After thirteen months of a historic stock market plunge (yes, the worst since the Great Depression), occasionally interrupted by the usual sucker's rallies (of which last week's move may be the latest or may be the start of a recovery), the stock market is, finally, back to a rough approximation of fair value.
The best measure of fair value is the "cyclically adjusted P/E ratio," which smooths out the fluctuations in corporate profit margins by averaging earnings over 10 years. (The straight P/E ratio, based on one year's earnings, can be wildly misleading: when profit margins are high, P/Es look comfortingly low, and vice versa. Profit margins are highly mean-reverting, so the cyclically adjusted P/E gives a far more accurate picture of market value).
The cyclically adjusted P/E ratio is used by Robert Shiller, Jeremy Grantham, John Hussman, Andrew Smithers, and other analysts. As with most valuation analyses, the underlying assumptions are debatable (e.g., will P/Es be higher in the future than they have been in the past?), so estimates of fair value differ. But most of these folks put fair value for the S&P 500 in the 850-1050 range, and Smithers puts it right at 900.
Andrew Smithers' most recent chart showing the S&P 500 relative to its own average on two valuation measures: cyclically adjusted price-earnings (CAPE) and Tobin's Q, which is a measure of replacement cost. The chart is from early October, when the S&P 500 level was 909.
(See chart here)
"Fair value" (the green line) is fair value because the S&P 500 has historically spent about half the time below that level--often after spending many years above it. Given the cyclicality of this ratio, if I had to guess, we'd say the S&P 500 is in for a decade or two of below-average values, which argues against the idea that we're suddenly going to have a strong, sustainable valuation recovery.
More likely, the bear market that began in 2000 (after an 18 year bull market) will likely continue for another decade or so, during which stocks will occasionally become truly cheap--as they almost did a week ago, when the S&P 500 hit 750.
The good news is that, after 15 years of being overvalued, the S&P 500 is finally priced to deliver an average long-term return: about 9%-10% in nominal terms and 6% after adjusting for inflation. That's nothing to scream and yell about, but it's likely to be a lot better than cash.
See Also:
Grantham: Stocks May Fall Another 50%, But Still Time To Start Buying
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They want you to invest so they can inflate the value of their stocks and sell out before it decline and leaving you holding th bag. Smart money (at least those who can't afford to take the hit and don't have the inside track as when to sell) would get out of the casiono known as the stock market. But greed keeps you suckers going back, dreaming of striking it rich. Dream on, suckers.
Gold at least 5% in your poortfolio for the next 2 yrs,little oil too. Buy a home next spring. This is why we love America, right?
So, if you buy stock now, you will get this 9 to 10% return. If you bought stock the last few years, your return will be what? 5%, 3%/
The S&P at 900 puts it back to 2003 levels.
Another 50% drop would put it back to 1994 levels.
Very interesting post. Yikes - another 50% loss. Well, I don't think i could stomach that. But interesting argument about the value of stock.
The reason your long term holdings are down is some person took your money and ran away.
The only way you will get your money back is to hope there is a large group of people who buy the bilge and start contributing large amounts of cash so you can wait for a rise in price and perhaps get out first.
Then you can take their money and you can run away!
Remember, for every dollar you make in the market, some poor smuck has to lose a dollar.
Good Luck!
Is RenoSage serious...get rid of hedge funds and speculation will be
abolished...take a class in Finance 101 as soon as possible, sir, you're
hugely undereducated...otherwise, Rule Of Law is much closer to what's
going on..."goat slaughtering...and entrail reading," indeed...
Well Hef, who are the goats? Being you're all edgeumacated and stuff...
No, I think the short selling is one of the problems. Not THE problem but one of many. For what it's worth, even Paulson admitted to that - and he should know.
It's only good news for people who's been investing for ten years or more and have the time to wait for the stock market to correct itself. If you started to invest within the past few years, you got hosed.
It is only good news for investors if they outlaw short-selling. Then the speculators will be eliminated
and only the serious investors remain.
Sadly accurate Anthony - My 401k's & Equivilents date from less than 1995.
I,... count myself among the hosed,...
Sorry son . . . not yet.
Yeah, that sounds about right. I had expected a 50% correction from the Dow peak, which we pretty much got down to last month. I would agree that we've probably seen the bottom or pretty close to it; which is not to say that we won't bounce around it for a while longer.
However, Housing Prices are still far enough off of any reasonable, historical trend line that I think there's probably another 10--20% drop in them before the mess is cleaned up.
the old highs were made possible by a good economy and they buying pressure of 30-or40 to 1 leverage.
they have not repealed the law of supply and demand . at 40 to 1 leverage one can argue past demand was somewhat superficial/artificial and not likely to return any time soon.if we are now back to fair value prices were artificially high.
so what is there to drive the prices to the old highs? if you straight line the potential growth at 5% per year and eliminate any bear markets it is going to take a very long time to get back to pre-crash levels.
I think we agree. Just because I said we've hit the bottom (and will bounce up and down against it for some time) doesn't mean that we're going anywhere near the artifical highs we've left behind for a very long time.
"MOST OF THESE FOLKS PUT FAIR VALUE AT 850-1050 .
that is a 200 point spread or almost 25% from 850 .
25 % margin of error can be acheived by a total novice .
analysts who make their living doing this ought to be able to do better than that.
25% margin should disqualify that opinion from serious consideration especially when you are looking at 6% gains.
Don’t stock market analysts who make public comments throw bones or read tarot cards for their predictions? So long as they can keep up with the general market, their clients won’t yelp. And they can sell books and give lectures about how to make a $million for pocket money. So long as Americans admire gamblers (and when haven’t we?) the game just keeps on going. Every system can and will be gamed. Ignore it and the drama of win/lose gets exaggerated. What a waste of the only life we are given!
I think there is also goat slaughtering involved, and entrail reading...
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