hi Bruce,
I wanted some sort of a combined effort of gathering certain information from historic charts that demonstrated when interest rates are x.x, the inflation rates is x.x, the yield curve is x.x and dividend yields are x.x - then a price to earnings multiple based on trailing twelve months can be expected to have a mean average of _ _
alas, the market behaves in strange ways. it does not always have the same PE when rates are X and inflation is Y. but i think history is a guidepost not to be dismissed for providing us with a range of values.
Any of my tone of being dismissive comes through when I read a comment that simply says "in past bear markets PE ratios fell to 7 (or 10 or 11 or 17 or 20 or whatever the number) and so this market is still overvalued until it hits one of those previous numbers."
i certainly don't think the market HAS to go to any particular number, though i do think there are a couple basic points worth remembering:
* we were in a bubble
* the bubble ended
and based on looking at 40 past bubbles throughout history, Grantham and his associates found that they ALL gave back the entirety of their speculative gains.
now that doesn't mean that the market MUST go to a PE of 7 or whatever and become extremely undervalued (though that is a possibility); however, for my personal purposes (i don't have clients who can fire me for tracking error), i find it reasonable to assume that the market will correct to at least its historical means.
and if you look at the comstockfunds.com data, they have an interesting table that lets you compare today's values to other times in the past based on a variety of historical measures comstockfunds.com
you can plug in your own expected values, or a range of values.
personally, i think a range is useful because we cannot know these things with accuracy in advance. and that is why, personally, i have established a range of equity allocation percentages i would take, according to the expected returns.
i fully acknowledge that this might be the first popped bubble in history that only sort of deflates, but then maintains a valuation some 50% higher than historical norms forever. but i doubt that will come to pass.
well, not all stocks 'fit' and meet the PE trough criteria. There are always some above the mean as well as below the mean. So to say that Cisco (or pick a MSFT) must drop to a PE of x.x or xx.x or whatever because that's what happened in 19xx can be misleading
it is really a discussion of the market as a whole, because individual cos will do their thing (within a range that is affected by the broader market and their particular asset class).
btw, i agree with you that the PE may not call the low on the market, because in really bad markets like the early 30s the PE can get very high (due to very low earnings). but even then, the market was extraordinarily cheap based on other measures like price-to-book (and indeed book value, or "book-to-market", is one of the three factors used in famous three-factor model of French-Fama).
If we plug in all of that data and say that current PE ratios must fall to the same level as the level reached in the early 70's at that bear market bottom, then I would want to discuss the high inflation, high interest rates, higher dividend yields and a variety of other things to say that the PE trough then may not represent what the PE trough this time will be.
good points. again, i find it useful to look at a number of these factors and understand that we can establish no more than a range. i do not really expect them to hit historical lows this time 'round (e.g., PE of 6 on the market), but i would be surprised if the market PE, for example does not fall to its norm (say at least 17) over the next decade. |
