Skip to main content
Message Font: Serif | Sans-Serif
No. of Recommendations: 10
This is the headline from my latest column for, which was published earlier today. It's all here except for the chart. If you are a RealMoney subscriber, click here to see the chart. Hewitt

I told RealMoney subscribers in March that the S&P 500 was pricey at 1298. My opinion was based on a valuation process from Yale professor Robert Shiller.

I concluded:

"The lesson of this chart is that while the S&P is a lot less expensive than the Himalayan levels of 2000, it is still not cheap at 23 times earnings. Indeed, 127 years of stock market history shows just three other times when real 10-year P/E ratios breached current levels: 1901, 1929 and 1966. In each instance, the multiple later contracted to below 10 times. Mean regression can hurt!

Since then, the S&P has declined another 28%, turning upside-down the retirement plans of millions of Americans. To avoid the humiliation of seeing these losses in black-and-white, we toss brokerage statements into the trash, unopened. Our IRA has become junk mail.

Of course, Wall Street isn't golf -- we can't take a mulligan on 2008. So as painful as it is, we must keep moving forward, even though the future may look less sunny than we envisioned a year ago.

To determine whether stocks are now cheap, let's update our 10-year P/E. This multiple is the current price on the S&P divided by the average of the last 10 years' worth of "as-reported" net income. The lower this multiple, the more earnings power on some of the world's greatest companies.

The advantage of a 10-year P/E, rather than the more popular trailing-12-month variety, is the smoothing of the highs and lows of the business cycle. A few years back, financials were wildly profitable. Today, their earnings are punk. A rolling average reveals what is sustainable.

The current 10-year P/E is 15.8 times, based on Tuesday's close of 940.5 and 10-year earnings of $59.38. The average multiple is 16.3 times. Blue-chips look slightly undervalued by this measure.

The chart below suggests caution, however. Since 1881, the 10-year P/E has had five peak P/E months: June 1901, September 1929, February 1937, November 1965 and December 1999. Peak P/Es ranged from 22 times to 44 times.

After the first four peaks, 10-year P/Es fell to between 5 and 9 times. In other words, when the market overshot the average to the upside, it later overshot to the downside.

As for the 1999 peak? We still stand in its shadow, if the past is prologue. Further, history suggests the next bull market like we had in 1982 to 1999 will start after the 10-year P/E troughs in the high single digits. Based on $59.38 of earnings and a trough multiple of, say, 8 times, this implies a final dip to the high 400s on the S&P.

Some of you are disgusted with stocks and are tempted to go "all cash." If so, consider the late Philip Fisher's advice of keeping at least 25% of your portfolio in stocks. Otherwise, you'll feel like a dope for missing 11% days like Tuesday.

If you are liquid, buy companies with compelling reward-to-risk profiles. Estimate intrinsic value and then buy when you have $3 to $5 of reward for every dollar of risk. Tilt the odds of investment success in your favor, especially since the market is in an unforgiving mood.

I use tangible book to create a worst-case scenario. For companies selling at less than tangible book, multiply the average of the last 10 years' worth of free cash flow by 8 times. This equates to a 12.5% earnings yield, which is an attractive spread to the risk-free rate of the 10-year Treasury.

Bargains abound. I am trembling -- but I am also trembling with greed.
Print the post Back To Top
No. of Recommendations: 0
Wow, this is some scary information. Thank you for presenting it, but i have a bunch of questions. I understand the fundamental element of the market being overpriced at a P/E of 15.8, but doesn't that mean that the previous dot com bubble could have inflated this figure before crashing down? In addition, doesn't this process put too much emphasis on tracking historical graphs?

I am not an expert in stock investing since i started off in July (oh boy was it a bad time to start), and from my short educational period, i learned that fundamentals are more important than technicals. So basically does that mean that "this time might be different"?

Plus its pretty scary when i hear fool members, writers and advisors telling everyone to buy the great bargains available today. While on the other side, i have such useful data about the market, as well as the work and thoughts of Thomas Nogales (whom i subscribed to, thanks for that! :) ) telling me that the market might crash again to more devastating lows.

Ps. Some emotional and psychological help would be appreciated lol
Print the post Back To Top
No. of Recommendations: 0
Aaaaahh, grasshopper.....
Print the post Back To Top
No. of Recommendations: 1
"...but doesn't that mean that the previous dot com bubble could have inflated this figure before crashing down? In addition, doesn't this process put too much emphasis on tracking historical graphs?

Intelligent observations.

The dot com and housing bubbles pushed the S&P beyond intrinsic value on the high side. Now, investors may push the S&P beyond intrinsic value on the low side. We won't know the answer for many years.

From my perch, the lesson of the chart that accompanied my Real Money article (excluded from above because I do not know how to copy-and-paste into a TMB discussion board) is how the S&P moves through these long but unmistable repetitive periods of enthusiasm and despair.

With the dot com and housing bubbles, that was enthusiasm. Now, we may be in despair.

The analogy I use is that the market ebbs and flows, just like the tide. This analogy is apt; 60% or so of a adult male's body is made up of water, and 95% of our brains are water. We may have climbed out of the primordial soup a billion years ago, but we still have water in our ears, it would seem.

Do you know if you bought the S&P in Sept. 1906 that 48 years later, in Sept. 1954 it was still at 250 (with lots of ups and downs along the way.) Even with reinvested dividends, imagine waiting 48 years before making a capital gains (pre-inflation).

As for putting too much weight on history, well, this is the benefit of using rolling 10-year averages. If you bought the S&P a few years ago the financials would have contributed an abnormal amount to the numerator Earnings. Now, the financials will under-contribute to the S&P, given their parlous state. By averaging earnings over 10 years (a Ben Graham idea), the highs and lows get smoothed out.

"...from my short educational period, i learned that fundamentals are more important than technicals."

I am not a technician, but the technical action on the S&P has been poor for many months. One simple approach is to compare the current level of the S&P to its 40-week moving average. If the S&P is in a bull market, it should trade higher than the 40-week average; if in a bear market, less than the 40-week.

Last Friday the S&P closed at 969. Its 40-week M.A. is 1273. So on a technical basis, the market is weak (and has been since Dec. 2007)

So basically does that mean that "this time might be different"?

Do you mean, Does this mean the S&P won't drop below the average PE...that we won't overshoot on the downside? I think we will. This is the lesson of 130 years of stock market history. But today, Nov. 6, 2008, I also own lots of good-to-okay companies selling at great prices.

Print the post Back To Top
No. of Recommendations: 4
Important caveat to my comments above: If inflation heats up, we may have seen the price lows on the S&P last month. This is because as the Fed puts more money into our economy, the extra supply will chase stocks, pushing prices higher. Of course, inflation will result in the loss of buying power, so on an inflation-adjusted basis we lose. Dr. Shiller's 10-year PE's are calculated in an inflation-adjusted basis. To lean more, go to ...

...and then click the link in this paragraph:

"One can access an Excel file with the data set (used and described in the book) on stock prices, earnings, dividends and interest rates since 1871, updated.

Every weekend I estimate the year-over-year growth in the U.S. gross public debt. The latest data shows growth of 15.9% annualized, vs. "just" 7.1% in August. I believe this rapid growth rate is a harbinger of inflation, which will punish savers and bondholders. In nominal terms, stocks will rise. On an inflation-adjusted basis I still think we hit the 10-year PE lows of prior market troughs.

Print the post Back To Top
No. of Recommendations: 0
Maybe this will help you.
" With the S&P 500 down nearly 40% from last year's highs, and now trading modestly above 10 times last year's peak earnings level, I continue to view stocks as somewhat undervalued, in that long-term investors can expect the S&P 500 to deliver total returns in the area of 10% annually over the coming decade. This is the largest expected return premium, relative to long-term Treasury yields, since the early 1980's.

These changes have significantly improved my views about market valuations and long-term return prospects, but I want to discourage any impression that stocks have “hit bottom” or that a new “bull market” is at hand. That sort of thinking isn't really helpful to investors, who should always be grounded in observable evidence (rather than trying to infer things like bottoms and turning points, which can only be identified in hindsight). Frankly, the idea of identifying those things in real time is wishful thinking. Investors should not rule out a continued bear market, or deeper lows, perhaps early next year (depending on the evolution of the economic evidence). Still, even in the context of a continued bear market, we may well observe a huge 25-35% trading range as evidence develops, pushing and pulling on the perceptions and expectations of investors. Better to be comfortable with uncertainty and thoughtfully adapt to observable evidence as it develops, rather than planting a flag in the ground and being trampled from both sides. "
Print the post Back To Top