S&P 500: The Best Risk/Reward in 20 Years

The past few days have been rather uneventful, at least as far as the market is concerned. In fact, the only thing that I have taken issue with over the past few days is the constant talk about 2009 earnings and what that means for the S&P 500. The theory goes something like 2009 earnings (and maybe 2010) earnings will be weak and therefore the S&P 500 won’t recover.

It seems pretty straightforward: if the S&P 500 has earnings of $40 and you use a 15x P/E multiple, then the S&P 500 will end up around 600. The question is, does it really make sense to invest on next year’s earnings?

The market isn’t always rational, so it may make sense to invest with only a view toward next year’s earnings. If you have a longer term view, however, then now is probably the best risk/reward you’ve gotten from the market in about 20 years. The below charts show the S&P 500 earnings since 1950, their 10 year moving average, and the S&P 500’s price to 10 year average earnings.

As you can see, the S&P 500 has grown earnings by about 5.85% per year over the past 40 or so years, even when you consider the huge decline seen this year. You can also see that the price to 10 year earnings is back to levels not seen since the end of the 80s. This is during a time when interest rates are zero.

So effectively, by buying the S&P 500 today, you are getting it while earnings and multiples are, historically speaking, low. Of course, that doesn’t mean that the market won’t be even cheaper tomorrow; it’s just pretty cheap now.

Comments

[CautiousInv...:]

There are several thoughtful pieces in Seeking Alpha today which explain the structural dynamics underway that will challenge growth in earnings in the next several years.

Consumers will deleverage and spend less, financial firms will suffer losses in the trillions and and corporations will deleverage.

As much as anything else, it's the deleveraging that will contain future earnings as there is a strong correlation between growth in corporate debt and earnings growth.

Jan 08 05:05 AM

[Billy Ford:]

Yes, you are right in that things are relatively cheap today, but it is hard to put faith in leveraged earnings as stated in the above post, and seeing what has happened because of excessive leveraging. I would venture to guess that a lot of people have taken their medicine and learned valuable lessons, or at least I hope they have, one could expect to see consumer spending rise at a lot slower pace next go round....but who knows...people are stupid sometimes, and will probably just do the same thing and we will be right back here in 5-6 more years..

Jan 08 08:41 AM

[Stephen Kanitz:]

I wish everyone would contribute with a graph or statistics as Nike Abe has done. We are all quantitatively literate, and a graph explains more than a 1000 words.

Jan 08 07:34 PM