excerpt from The Daily Reckoning:
- "Nor does history offer any comfort to today's stock
investors," Laing continues. "The last three stock
market manias that ended in 1901, 1929 and 1966-68 were
followed by 15 to 20 years of horrible average annual
returns, ranging between...zero [and] a negative 1.8%
after adjusting for inflation."
- Two decades of losses must feel like a very long time.
Most investors aren't prepared for twenty days of
losses, much less twenty years. Could such a dire
scenario actually come to pass? We don't know, of
course, but we do understand the math that suggests it
is possible.
- "If P/E ratios fall," says Laing, "the stock market
will cave [a verb...ed.] in the years ahead even if
profits exhibit sprightly growth. In the Seventies, for
example, the stock market was largely a range-bound
flatliner despite a tripling in corporate profits
because P/E multiples collapsed during the decade."
- At the moment, the S&P 500 is selling for about 40
times the last 12 month's earnings. Let's assume that
accounting gimmickry is flattering earnings by about 15%
on average. And let's assume further that deducting the
cost of executive-option grants would trim earnings by
another 20% (as several Wall Street firms estimate).
That would mean that honest-to-goodness earnings are
about 35% less than what is being reported! And that
would mean that the S&P 500's PE ratio is not 40 times
earnings, but more like 60 times earnings!
- Let's be charitable, then, and apply the same
calculations to EXPECTED earnings for the S&P 500. Based
on expected profits for the next 12 months, the S&P is
selling for about 26 times earnings. However, if we trim
earnings by the same 35% described above, the S&P is
actually selling for about 40 times honest-to-goodness
EXPECTED earnings.
- That is expensive, folks - no ifs, ands or buts. The
stock market would have to fall a whopping 65% from its
current levels to reach its historical average PE ratio
of 14 times earnings. Mathematical exercises like these
illustrate why it is easy to be bearish - or at least,
to be chicken.
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