Hear!, Hear! Let's have numbers, and a clear understanding of history. Down with BubbleThinking! We need to stop investing based on Concepts (= ignoring the numbers), and "it's different now" (= ignoring history, and all the long-term historical ranges and patterns). I'm not going to be convinced the Bubble is fully deflated, until I don't hear any more BubbleThinking, in the Business press and SI.
re: a quantitative estimate for the Nas: IMO, this is just impossible. The reason is, in the last 6 years, the Nas has been stuffed full of trash. Before 1995, a company had to have a proven market, a proven business plan, and a couple of years of earnings (real earnings, not the pro forma kind), before the IPO. Since then, hundreds of companies that don't meet that criteria had IPOs, as the brokers and venture capitalists saw an opportunity to move wealth from the Exuberant to the Rational. So, using the historical valuation ranges, and trying to calculate a reasonable valuation model for the Nas (how else can you try to predict whether the Nas will be at 1000 or 4000 next year?) is an apples-to-oranges comparison. The Nas is a different and uglier animal than it used to be, and predicting its behavior will be impossible, until much of the trash gets taken out, a process that has just begun.
So.....let's look at the S&P 500. According to my latest issue of BW, as of 6/19/01, that index is at a trailing PE of 28.1, and a forward PE (using 12M forward First Call consensus EPS estimates) of 21.5. So, the earnings of the S&P 500 were 1223/28.1 = 43.5, and the expected forward earnings are 1223/21.5 = 56.9. That implies an expected increase in earnings of (56.9/43.5)-1= 31%. How do we get an increase in EPS of 31%? The possibilities are:
1. sales increase by 31%, and everything else (margins, #of shares out, etc.) remains the same.
2. margins increase by 31%, and sales, etc., stay the same
3. earnings stay the same, and the EPS increases by 24% of outstanding shares being bought back by companies (using what? debt?).
4. some combination of the above.
Any other possibilities? No. And, #4 can't happen if 1-3 don't. Now, the macro situation is: sales are flat or declining, margins are flat or declining, earnings are flat or declining, and everyone is hoping (just hoping), that this turns around by late 2001. Well, if conditions worsen or are flat for the next 2 quarters, and then get better, then how can 1 or 2 or 3 happen? Answer: it can't. So, earnings estimates are still far too optimistic, on average. And, if earnings estimates still need to come down a lot, what is going to happen to the PE? Remember, PEs change in proportion to changes in 12M forward EPS changes.
OK, let's look at that trailing PE. It was 30.3 a year ago, and is now 28.1. So, valuations have got only slightly better over the last 12 months. (30.3-28.1)/30.3= a 7% decline in the PE over the last 12 months. I hope everyone could agree with me that the macro situation has worsened by more than 7% since July 2000. Last July, no one was anticipating (or pricing into stocks) an upcoming recession in the U.S., Europe, and Japan, all at the same time. Now, there is at least a 50:50 chance this is going to happen. This, of course, is a qualitative judgement. But I challenge anyone to give a detailed analysis, backed up by numbers, saying the situation is only 7% worse than it was 12 months ago.
The longterm range of the market is a PE of 10-20. That's where the S&P 500 has been, 90% of the time. During recessions (I'm not even considering what happens in depressions), the PE goes to 10. When the macro picture is perfect (no current or impending recession/inflation/war/deflation/overleveraged countries or major industries/etc./etc.), then we get a PE of 20. A realistic assesment of the current situation, is that we are in the mid-low range, between recession and "everything is perfect". So, a reversion to the historical trend, would indicate the trailing PE of the S&P 500 should now be in the mid-to-low part of the 10-to-20 range. Say, about 14. Half the current PE.
When predicting the future, investors overemphasize recent patterns, at the expense of longterm trends, in spite of the fact that longterm trends are a more reliable predictor of the future (there is a mountain of statistical evidence to back up this statement). Now, we haven't seen a PE of 13 for the market, for a while. And that is why most investors simply dismiss out of hand the possibility of that happening. Investors, as they always do, are extrapolating the recent past into the future. By "recent past", I mean everything since 1995.
Based on the above, I will continue cautiously buying the dips in increments, and aggressively selling the rallies. My portfolio is up 20% in 2001 so far, doing this, and I expect it to continue to be a better strategy than LTB&H, until something changes in what I've said above. And, the main thing I expect to happen, is that earnings expectations and valuations are going to come down. |
