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To: Israel who wrote (200908)	10/29/2002 4:02:12 PM
From: orkrious	Read Replies (1) \| Respond to of 436258

for the first time, you now have my company on EXPE. you're doomed <g>

To: Israel who wrote (200908)	10/30/2002 10:15:52 AM
From: ild	Respond to of 436258

More balanced view on SP500 earnings from John P. Hussman, Ph.D.: ... Investors continue to focus on earnings as the primary fundamental on which to value stocks. This is a mistake. Bears are using the S&P 500 "core" figure of about $19 to compute a P/E on the index of nearly 50. Meanwhile, bullish analysts are using optimistic estimates of "operating" earnings near $50 to compute a P/E on the index of just 17. Both of these are incorrect. First, current earnings are severely depressed due to weak profit margins. The pension and option cost adjustments made to the "core" earnings figures seem correct, particularly because these factors are much more relevant now than they have been historically (so leaving them out would overstate earnings power). But the sustainable level of earnings is probably about double what current earnings suggest. In contrast, operating earnings fail to deduct interest owed to bondholders and taxes owed to the government, not to mention options and pensions costs. Given that the share of earnings devoted to these items is the highest in history, leaving them out of valuation calculations is ridiculous. One way to cut through the noise is to recognize that earnings were wildly skewed, relative to other fundamentals, during the second half of the 1990's. At the market's peak, the S&P 500 P/E ratio was about double its historical average, while other measures such as price/book, price/revenue, price/dividend, and market capitalization / GDP were three or more times their respective averages. In other words, earnings were wildly elevated compared to other fundamentals. High earnings in relation to book value meant that the return on equity reported by companies was unusually high. High earnings in relation to revenue meant that the profit margins were unusually high. High earnings in relation to dividends meant that payout ratios were unusually low. And high earnings in relation to GDP meant that the profit share of GDP was unusually high. We have since discovered that much of this was either temporary (due to an unsustainable capital spending boom with predictable consequences), or fraudulent. In any event, it is very clear that future earnings are unlikely to recapture their unusual relationship with other fundamentals. And there is the problem. Because, on the basis of any fundamental other than earnings, valuation multiples (price/revenue, price/book, price/earnings, market cap/GDP, etc) remain 50-100% higher than their historical averages (not to mention typical levels seen at bear market troughs). For this reason, we are skeptical of claims that stocks are close to fair value here. A final note on the "Fed Model" (S&P 500 operating earnings yield divided by 10-year Treasury yield). This is a model of the stock market in the same sense that a pile of Pez candy is a model of the Taj Mahal. I've long noted that this indicator actually has no statistical relationship with how the S&P 500 performs over the following year (or any other period for that matter). Indeed, the usual way that the Fed model generates a "buy signal," particularly in recent years, is for 10-year Treasury yields to drop to abnormally low levels. That observation led me to an entertaining statistical result. It turns out that although the "Fed Model" is useless as a stock market indicator, it's actually not a bad bond market indicator. Specifically, when the Fed Model gives a "buy signal," (particularly when earnings yields on the S&P 500 are not high) it's typically a signal that the 10-year Treasury yield has become unusually depressed. Statistically, this is nicely correlated with a subsequent plunge in bond prices. In other words, when the Fed model suggests that stock yields are "too high" in relation to bond yields, stocks don't adjust, bonds do. hussman.com