Are Stocks Really Cheap?

By Eric Roseman

Since August 2007, the market has logged four bear market rallies and all of them ended badly.

From its lows earlier in October the S&P 500 Index has gained 5% and the Dow is up about 3%. The MSCI World Index has gained less than 1% from those same lows, constricted in great part by a surging American dollar.

But are stocks really cheap?

Global equities are now trading at their lowest trailing price-to-earnings multiple since the 1970s at just 10.3 times earnings. The majority of global markets have been mauled lately and virtually all of them sell at less than 12 times earnings and some below ten. Europe, the Pacific and Latin America all trade at compelling levels.

Yet U.S. stocks don't necessarily appear that cheap when compared to international equities or when priced in relation to their 12-month earnings and dividend payments.

The S&P 500 Index trades at 21.3 times trailing 12-month earnings and yields 3.2% in dividends.

According to Wigmore (data from 1985), U.S. stocks peaked in 1929 trading at 30 times earnings and harboring a 3% dividend yield. But by 1932, U.S. equities traded at just 10 times earnings and yielded a fat 12.5% dividend yield.

Stocks thereafter embarked on a big rally of 67% in 1933 and another 38% in 1935. This followed the incredibly painful crash from October 1929 until late 1932 when the Dow collapsed a cumulative 87%.

Historical data therefore suggests that U.S. stocks are still not huge bargains. It also suggests that we're still in the throes of a bear market rally.

But as the credit crisis continues to relax, the damage has already largely been done to the real economy. Credit is still hard to secure, consumers aren't spending, retail sales are grim and layoffs are now widespread. Mortgage rates remain elevated. Consumers will eventually start saving again, and that is only bearish for corporate earnings. If consumers save, they don't spend.

We're now transitioning from one crisis to another, or going from the tail-end of a credit squeeze to a deep global recession that affects broad consumption. I highly doubt the market has discounted all the bad news. I also find it hard to believe that the Panic of 2008 and its horrific trail of damage, namely the destruction of wealth, will keep the market above water for very long. The Dow will at least re-test its 2002 levels at 7,200. Stay defensive.

Disclosure: no positions

Comments

[Steven Hansen:]

sad, but well said. i will bookmark this post to re-read whenever i start feeling good.

2008 Nov 12 04:41 AM

[investor88:]

Good article and like The hand, be careful whenever you feel good because that may be precisely the moment to go short! With all the problems unsolved and probably getting worse, how can the market bottom?

2008 Nov 12 07:55 AM

[MikeLovesGold:]

Spot on - great article.

2008 Nov 12 08:54 AM

[JasonC:]

Trailing 1 year earnings never indicated anything to anybody. It isn't a time series with any inherent stability, until you moving average it.

As soon as you do, you will find stocks are indeed cheap, especially given prevailing interest rates, and especially in the distressed sectors. In long term retrospect, this is going to look like a fine time to have bought --- every decline this large in history, has.

But don't even try to time it --- timing is impossible. Dollar cost average. Corporate spreads have widened enough that A rated corporates are immediate buys. Invest all the coupons in stock, as you receive them. This will average you into a larger stock exposure on the right time scale, and on corporate America's dime.

2008 Nov 12 11:22 AM

[sr9web:]

Stop comparing everything to 1929 era. So much has changed about trading, that it's not a clear comparision. People are basically the same, but the total trading environment is different. And, back then, there was a much more limited universe of stocks. And all of them rose and fell together. Today, there are a number of ways to still trade for winners - if you pick and trade carefully. Everything is down, but the foundations of real wealth are already being built in some corners of the market.

2008 Nov 12 08:59 PM