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How low can the market go?


twacowfca
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There have been eight steep declines in the US stock market of sixteen percent or more in a short period of time since 1928 like the current pullback, according to Bespoke Investment Group.  All of these have been followed by additional declines, averaging seventeen percent deeper losses. :o

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S&P 500 is trading at 9.97x next year earnings, and this is before QE3, which is going flood those leading companies with even more profitability. If the market declines another 20% those leading businesses will be trading, on average at 7-8x next years net income.

 

In Europe the average forward multiple is currently between 7-8x net income, any further decline will mean ~5x

 

Based on this graph: http://en.wikipedia.org/wiki/File:Price-Earnings_Ratios_as_a_Predictor_of_Twenty-Year_Returns_(Shiller_Data).png

 

This is an incredible buy opportunity.

 

 

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S&P 500 is trading at 9.97x next year earnings, and this is before QE3, which is going flood those leading companies with even more profitability. If the market declines another 20% those leading businesses will be trading, on average at 7-8x next years net income.

 

In Europe the average forward multiple is currently between 7-8x net income, any further decline will mean ~5x

 

Based on this graph: http://en.wikipedia.org/wiki/File:Price-Earnings_Ratios_as_a_Predictor_of_Twenty-Year_Returns_(Shiller_Data).png

 

This is an incredible buy opportunity.

 

 

 

Or is it?  Take a closer look at the Shiller graph.  It's based on a PE10, not a current, forward PE.  The last time I checked the PE10 was about 23.  With the recent decline, it should be between 19 and 20.  The graph shows the midpoint of future gains over the next twenty years to be about 2% to 3% per annum when the PE10 is at that level.

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S&P 500 is trading at 9.97x next year earnings, and this is before QE3, which is going flood those leading companies with even more profitability. If the market declines another 20% those leading businesses will be trading, on average at 7-8x next years net income.

 

In Europe the average forward multiple is currently between 7-8x net income, any further decline will mean ~5x

 

Based on this graph: http://en.wikipedia.org/wiki/File:Price-Earnings_Ratios_as_a_Predictor_of_Twenty-Year_Returns_(Shiller_Data).png

 

This is an incredible buy opportunity.

 

 

 

Didn't we have an extraordinary contraction in earnings during the financial crisis?

 

Or is it?  Take a closer look at the Shiller graph.  It's based on a PE10, not a current, forward PE.  The last time I checked the PE10 was about 23.  With the recent decline, it should be between 19 and 20.  The graph shows the midpoint of future gains over the next few years to be about 2% to 3% when the PE10 is at that level.

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Goldfinger nice to see im not the only one that reads Adam Hamilton.. he is awesome!

 

Twacow, I don't have the figure on the 10 year trailing avg PE Ratio, but it would surprise me if it is in fact 23 for the SP?

 

Shiller's latest calculation of the S&P500's PE10 after the recent unpleasantness in the market is 19.39. :)

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One more thing I must opine on given that ties into the other thread. I think it is incorrect to measure the Shiller research in any period other than POST 1971, when global financial assets became denominated in fiat money. Since 1971, human beings have had the ability to increase the base money at will, and so I don't think its plausible in a fiat money regime to hold your breath for 1920-1930 style trailing 10 year multiples.

 

That being said, under that basis your data still appears to indicate that a fall to around 10x trailing 10 year net income is more than possible.

 

It would be interesting to see a similar graph for the Japanese indices as our central bankers are now following the path of the japanese in terms of their monetary theories.

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I stand corrected on the trailing 10 year avg multiple. That is a good link too thank you.

 

I still think this is an incredible buying opportunity though, most of the companies I am buying are not trading at 19x ten year avg.

 

BP For example is trading at 8.5x TRAILING 10 year avg net income.

 

Yes, But oil is a cyclical business.  That industry is coming off a huge ten year period of awesome profits.

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Twacow that is a totally arbitrary statement, how the heck do you know that the industry is "coming off a huge ten year period of awesome profits"

 

There is no evidence to suggest that the next 10 years cannot be better for the oil producers than the last. It all depends on the market for crude which is pretty darn good right now.

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One more thing I must opine on given that ties into the other thread. I think it is incorrect to measure the Shiller research in any period other than POST 1971, when global financial assets became denominated in fiat money. Since 1971, human beings have had the ability to increase the base money at will, and so I don't think its plausible in a fiat money regime to hold your breath for 1920-1930 style trailing 10 year multiples.

 

That being said, under that basis your data still appears to indicate that a fall to around 10x trailing 10 year net income is more than possible.

 

It would be interesting to see a similar graph for the Japanese indices as our central bankers are now following the path of the japanese in terms of their monetary theories.

 

Balance sheet depressions/recessions like the recent one in Japan or the US and most other developed countries in the 1930's are associated with PE contractions, but highly inflationary periods are also associated with PE contractions that are as bad or worse.

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Twacow that is a totally arbitrary statement, how the heck do you know that the industry is "coming off a huge ten year period of awesome profits"

 

There is no evidence to suggest that the next 10 years cannot be better for the oil producers than the last. It all depends on the market for crude which is pretty darn good right now.

.

 

Many industries, including oil are cyclical.  When a cyclical downswing coincides with a secular downswing: Watch Out!  The recent oil boom has largely been driven by China.  If their economy rolls over, it's triple trouble.

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Keep in mind that BP is a somewhat unique case.

 

Demand can vary, but the supply from each cheap oil/gas source falls every year as the field plays out. To meet the supply shortfall the world taps successively higher cost sources, & keeps increasing the base price paid for the product. A decline in demand just means that the world taps the higher cost sources a little slower. The price actually paid reflects the fundamental crude specific demand/supply (Brent, West Texas, etc), futures speculation, & currency change (USD devaluation).

 

Buy BP & you buy skeletons, government sanction, access to cheap oil/gas sources, & the ability to reinvest in tertiary production at the lowest possible cost & greatest certainty (know the geology, location, etc). For someone else to access the goods, it has to be another sovereign company/fund & sanctioned by both governments (UK & ME). Does happen (Saudi-Aramco), but not often.

 

Its cheap because some of the skeletons came out of the closet (Gulf disaster) & global crude demand is perceived to be falling, but nothing else has really changed. 

 

SD

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Twacow that is a totally arbitrary statement, how the heck do you know that the industry is "coming off a huge ten year period of awesome profits"

 

There is no evidence to suggest that the next 10 years cannot be better for the oil producers than the last. It all depends on the market for crude which is pretty darn good right now.

.

 

Many industries, including oil are cyclical.  When a cyclical downswing coincides with a secular downswing: Watch Out!  The recent oil boom has largely been driven by China.  If their economy rolls over, it's triple trouble.

 

Where is the oil going to come from going forward for existing consumption only?

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I guess the real question is how useful is the PE10 in projecting a low for a value oriented portfolio?  If you are investing in index funds it probably is useful but I know the composition and weighting of value portfolios can be signifcantly different than the index.  However, if you are investing in individual stocks (many of which are not in the index) then wouldn't finding cheap stocks be a better indicator of when / what to buy?  I know I own maybe 1 or 2 S&P 500 stocks out of a 20 stock value portfolio.  A more useful benchmark may be some Joel Greenblatt's funds as they are screened and value weighted indexes.  It would be great if there was some historical info on such indicies.

 

Packer

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History suggests poor overall market returns going forward like the returns for the last decade.  However, that's a great time to carefully trade in and out of carefully selected value stocks because the volatility will periodically throw up bargains.  This is much better for good value investors than a bull market that rises into a bubble because the only choices then are to drink Mr. Markets Kool Aid or sit on the sidelines.  :)

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I think that PE10 should be lower during periods of higher dividend payout ratios.

 

In other words, if earnings are retained to grow the business or to buy back shares, then PE10 should be higher as earnings growth per share would be relatively higher during the period (relative to just paying out the earnings as dividends).

 

 

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