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John Lounsbury, Managing Editor and Co-founder of Global Economic Intersection, provides comprehensive financial planning and investment advisory services to a small number of families on a fee only basis. He has a background which includes 34 years with a major international corporation, 25... More
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  • Chart of the Day - PE Ratio 16 comments
    May 22, 2009 11:32 AM

    It is interesting to note that the low PE ratios that used to be associated with bear market bottoms (between 6 and 10) have not been achieved for the bears of 1990 and 2001-02, as well as so far in this cycle.  The chart is courtesy of  http://www.chartofthed... 

     

     

     

     

     

     

     

     

     

     

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Comments (16)
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  • kruser53
    , contributor
    Comments (120) | Send Message
     
    You didn't comment on the PE ratio. Even if earnings double in the next year and stock prices don't change, PE ratios will be over 60. That is still above the previous record levels.

     

    Thanks for posting this chart.
    22 May 2009, 12:02 PM Reply Like
  • mikebrah
    , contributor
    Comments (253) | Send Message
     
    John,
    Do you take this chart as evidence of a "new normal" since removing the gold standard and thus creating higher and higher "bottoms" do to fiat currencies? Or do you take it as being potent evidence of a severe detachment from reality and an especially painful reversion to the mean? Or something else entirely...?

     

    Thanks,
    MM
    22 May 2009, 01:53 PM Reply Like
  • John Lounsbury
    , contributor
    Comments (4048) | Send Message
     
    Author’s reply » Mike - - -

     

    I don't think leaving the gold standard, which started in 1971 and was finalized in 1973 is directly related to market valuations. The relationship is second order. The last three PE minima occurred in 1974, 1982 and 1983. It could be argued that these three are related to the inflation (and high interest rate) bubble that occurred during that time. I will leave it to others to argue whether that had a first order cause in the abandoning of the gold standard. Higher interest rates tend to supress stock prices and PE ratios (money goes where it is treated best).

     

    Two of the other three PE ratios below 10 occurred during the 1930-40's when interest rates were low, but there was still economic distress. The final low PE ratio occurred in 1949 following a period of very high inflation.

     

    The higher PE minima occurred during the periods 1954-70 and 1987-2007. These are what I would call Goldilocks periods. Interest rates were low, inflation was largely contained and there was relatively little volatility in GDP.

     

    So, to get to your "new normal" comment, I think that high PE ratios at minima may become the "old normal" (continue the behavior seen from 1987-2007) if we go into a prolonged period of economic distress, whether like the depression years or high inflation years. We could continue to observe PE minima above 10 if Goldilocks is not dead, but simply taking a nap.

     

    Good question, Mike. Sorry for the equivicating answer.
    22 May 2009, 02:22 PM Reply Like
  • dcb
    , contributor
    Comments (1360) | Send Message
     
    this is what happens when the government gets involved in supporting the markets. We don't ht a true bottom and only delay the pain for later. this time we are seeing the effects in the dollar. We only hit a bit below long term averages anymore. We barely touched fair value this time around.
    22 May 2009, 07:07 PM Reply Like
  • dcb
    , contributor
    Comments (1360) | Send Message
     
    I will add this is what happens when the government allows the markets to be rigged.
    22 May 2009, 07:09 PM Reply Like
  • derryl
    , contributor
    Comments (1043) | Send Message
     
    I think moreso now than at any time since the late 1920s, stock are being bought on share price speculation rather than as dividend paying investments. If you can buy a 30/1 stock for $12 and sell it a month or two later for $16, who cares about the earnings of the company whose stock you just made profit from? I'm not arguing the morality of speculating vs. investing. I'm just offering a possible explanation for enduringly high P/E ratios.
    22 May 2009, 07:38 PM Reply Like
  • mikebrah
    , contributor
    Comments (253) | Send Message
     
    Good comment. And combined with the fact that a much larger percentage of the populace is invested in the market than in anytime in US history and this could be a pretty valid explanation.

     

    The unsettling notion is that this would mean the pain will be exponentially greater if this turns out to be "the big one."

     

    On May 22 07:38 PM derryl wrote:

     

    > I think moreso now than at any time since the late 1920s, stock are
    > being bought on share price speculation rather than as dividend
    > paying investments. If you can buy a 30/1 stock for $12 and sell
    > it a month or two later for $16, who cares about the earnings of
    > the company whose stock you just made profit from? I'm not arguing
    > the morality of speculating vs. investing. I'm just offering a possible
    > explanation for enduringly high P/E ratios.
    22 May 2009, 08:14 PM Reply Like
  • jambo
    , contributor
    Comments (309) | Send Message
     
    It strikes me that even a return to sub par- to- medium earnings brings this chart right into the range John speaks of as New Normal. This would be a huge challenge with the jobless rate increasing but not so far fetched.
    The challenge is getting money back into the streets and (I think) out of the market. I know this may elicit a round of jeers from the market pros but I think I see a way to do exactly that:
    As I read the chart, the relative disregard of the P/E ratio came at about the time that so many of us "boomers" started to look around after partying for 30 yrs and began to realize that our precious (if hollow) lifestyle would not be sustainable if we did not begin to save/ invest in earnest!
    That we did and now, even though we were creating "THE" bubble in that process, we want to keep it, as well we might.
    I was fortunate enough to heed some advice in early '07 and by Aug was well clear of any stocks/ bonds/ funds except for short term treasuries. Needless to say I did not make a bunch but preserved my precious boomer bucks, dabbling in gold and some shorts, no big deal. By and large there (in my IRA) it rests today, largely retired, as am I, and earning little--- but more importantly--- DOING LITTLE AS WELL.
    I postulate this question to any who may respond: What If, in a joint action of parties in congress, we moved to allow a one time only move from our idling IRAs and 401Ks, TAX EXEMPT, directly into or against our mortgage. Would that not feed capital against the very most negative issues in the Banks (in the broadest sense) portfolios? And at the same time provide some new capital for lending in a new and more responsible way.
    Clearly the Gov would want to preserve those taxes for themselves BUT wouldnt they (we!) be better off in the long run by not printing the money to give the financials and making up the difference in the long run through taxes on a better economy?? Not to mention the added spending ability of those of us who would now have no, or much lower, home payments. Just think of the benefit in terms of avoiding the massive human suffering that we all know is on its way.
    I ask; Is this just a pipe dream? Or Is it something that those of you with the obvious brain power and good sense that you display in your articles and responses could get behind and help along?
    I am not schooled in finance and there may be challenges to making it work, but please tell me if you think it has any merit. How do I go about posting an article or submitting it for site approval? Do I need credentials?
    As I used to say when designing production tooling, "hey, I'll take an idea from the sweeper if it has some merit". So I dont care if they pretend it was their idea all along... lets just get this thing moving again for all of our sakes.
    repectfully
    j
    23 May 2009, 04:08 PM Reply Like
  • John Lounsbury
    , contributor
    Comments (4048) | Send Message
     
    Author’s reply » Jambo - - -

     

    You have done well investing. I think the key to success has been prudent caution and not being too greedy.

     

    With regard to your suggestion about passing a law to allow a one-time retirement account withdrawal tax-free for the purpose of paying against an existing mortgage, I think the following questions arise:

     

    1. How many people who have mortgage difficulties have significant dollars in retirement accounts compared to the size of the mortgage? I have read somewhere that the median 401(k) plan balance is in the $20-30,000 range. This is less than the size of many mortgage problems for purchases made 2004-2007.

     

    2. How many people would object that they did not qualify for such a "bailout" because their mortagae situation was healthy? Would the process have to be extended to everyone? Even to people who wanted to buy a home?

     

    3. Is it really sound financial planning to move from tax deferred compounding at one rate (401(k) or IRA) of return to a lower rate of return (say 2-3%, the historical average appreciation for residential real estate) into an illiquid asset (a home)? Unless the mortgagee has equity in the home (many have negative equity today), the proposal does not make sense for the individual. Of course the average 401(k) account has probably returned much less than 2-3% over the past 10 years, but we might see better returns over the next 10 years.

     

    Now that I have played devil's advocate, your idea is worth discussing. If you have some thoughts on the issues I raised (or others I haven't mentioned) you could organize an article that might be quite interesting and start a good discussion.

     

    The process for submitting an article is defined in the second column at the very bottom of the SA home page.
    23 May 2009, 11:48 PM Reply Like
  • jambo
    , contributor
    Comments (309) | Send Message
     
    On May 23 11:48 PM John Lounsbury wrote:

     

    > Jambo - - -
    >
    > You have done well investing. I think the key to success has been
    > prudent caution and not being too greedy.
    >
    > With regard to your suggestion about passing a law to allow a one-time
    > retirement account withdrawal tax-free for the purpose of paying
    > against an existing mortgage, I think the following questions arise:
    >
    >
    > 1. How many people who have mortgage difficulties have significant
    > dollars in retirement accounts compared to the size of the mortgage?
    > I have read somewhere that the median 401(k) plan balance is in the
    > $20-30,000 range. This is less than the size of many mortgage problems
    > for purchases made 2004-2007.
    >
    > 2. How many people would object that they did not qualify for such
    > a "bailout" because their mortagae situation was healthy? Would
    > the process have to be extended to everyone? Even to people who
    > wanted to buy a home?
    >
    > 3. Is it really sound financial planning to move from tax deferred
    > compounding at one rate (401(k) or IRA) of return to a lower rate
    > of return (say 2-3%, the historical average appreciation for residential
    > real estate) into an illiquid asset (a home)? Unless the mortgagee
    > has equity in the home (many have negative equity today), the proposal
    > does not make sense for the individual. Of course the average 401(k)
    > account has probably returned much less than 2-3% over the past 10
    > years, but we might see better returns over the next 10 years.<br/>
    >
    > Now that I have played devil's advocate, your idea is worth discussing.
    > If you have some thoughts on the issues I raised (or others I haven't
    > mentioned) you could organize an article that might be quite interesting
    > and start a good discussion.
    >
    > The process for submitting an article is defined in the second column
    > at the very bottom of the SA home page.

     

    Thanks John, for taking the time and energy to throw some of your much valued thinking my way.
    First , I had no idea the median for 401s & IRAs was that small. Is that number due to the recent havoc? Either way, my thinking is; every bit will help, the more cash moving the better for all.

     

    Second, I would not restrict the money flow from those with healthy mortgages! Why not allow that tax saving for everyone with a mortgage? The point would be to get the money into the economy by filtering it through those mortgage holders/ lenders. As I'm sure you know, it has become increasingly difficult for regular folks to get a decent loan on a decent property. I view that as a normal but perhaps slightly over-reactive adjustment to current circumstances. Having fresh, real cash to lend might help? And I dont see the suspension of taxation as a bailout, at least not in the same sense as printing bogus money. It IS ours after all, at least before the gov stakes its claim.

     

    Third, this is not about speculation on the growth of property value. I think logically we have to put that one aside for the near to medium future. With some cash moving around again I think letting it mark to market is just fine, it will all resolve as the economy improves which in ANY case I believe will be slowly.

     

    Now, this pre-supposes that you wish to STAY in your home. The way I see it, we have to live somewhere and I'm far less concerned about its investment value than in having a sure place to live while we all weather this storm.

     

    That said John, I'm of the 'penny saved...' school of thought: If I can take 100/ 200/ 300 thousand (or more out here in Calif) and put it against a loan I'm paying from 5.5 to 8 percent on, well then that is how much I'm making on my 'new' investment, right? Personally, that would be large for me. I would jump at the chance to 'save' that kind of interest. Especially as my available (or actually unavailable) cash is either on vacation or must be managed very actively to minimize the risk involved to duplicate those returns (in our case about $2500 mo). I cannot afford that much risk at this stage of my life and would gladly take the sure 25c in the hand versus what MAY be in the bush. In thinking further, I'd bet there are a lot of 'boomers' who would do the same. I do have a friend with no equity in his home currently and he would also take a deal like that just so he could stay there as his income erodes. Of course I'm willing to discount that as being anecdotal evidence. We can each decide whether that situation may be duplicated in other households these days.

     

    Also, while I dont KNOW the relative weighting by demographics of 401/ IRA funds, I rather suspect that they are a bit more flush as the age of the holder increases. These are the people whose money we NEED to get back into circulation. If I need new flooring, or a bath upgrade, a fridge or heck, even wine storage, I now have an extra $2500 month to address these projects. I can see a lot of good jobs in that scenario AND paid for with CASH NOT CREDIT.

     

    And, what if I wanted to invest some of that cash flow into a second home or perhaps income unit... cant be sure but it looks like that would be some good news for housing industry/ market. Every unit purchased is one not languishing unpaid for, one whose skeletal remains are not dotting otherwise or formerly nice neighborhoods.

     

    Call me Pollyanna but I can see a lot of upside to these scenario.
    Once again, thanks so much and I am open to a complete debunking of the entire thing if that is what the cold light of truth has in store. It is always about helping my family and others to help themselves.
    24 May 2009, 02:49 PM Reply Like
  • mr freddo
    , contributor
    Comments (291) | Send Message
     
    More evidence that we are not through this crisis and may be in the midst of an enormous bear market trap.
    23 Jun 2009, 12:54 PM Reply Like
  • thotdoc
    , contributor
    Comments (1966) | Send Message
     
    I think I'm as stunned as any rational investor with what is occurring; insider trading 60:1, P/E 140+, etc.

     

    It seems like our stocks are what our houses used to be.

     

    G
    3 Sep 2009, 08:13 PM Reply Like
  • Plant the seeds
    , contributor
    Comments (226) | Send Message
     
    Could be the starting of firms with high PEs and good prospects that are to be realized (or not) into the future? I think there is some research that a lot of sucessful firms are started in a recession.
    10 Sep 2009, 04:32 PM Reply Like
  • Plant the seeds
    , contributor
    Comments (226) | Send Message
     
    John,
    The development of capital markets globally and rapidity of response does raise questions whether the 1930s PE's can be compared to todays given the investing population for US equities has changed dramatically.

     

    On May 22 02:22 PM John Lounsbury wrote:

     

    > Mike - - -
    >
    > I don't think leaving the gold standard, which started in 1971 and
    > was finalized in 1973 is directly related to market valuations. The
    > relationship is second order. The last three PE minima occurred in
    > 1974, 1982 and 1983. It could be argued that these three are related
    > to the inflation (and high interest rate) bubble that occurred during
    > that time. I will leave it to others to argue whether that had a
    > first order cause in the abandoning of the gold standard. Higher
    > interest rates tend to supress stock prices and PE ratios (money
    > goes where it is treated best).
    >
    > Two of the other three PE ratios below 10 occurred during the 1930-40's
    > when interest rates were low, but there was still economic distress.
    > The final low PE ratio occurred in 1949 following a period of very
    > high inflation.
    >
    > The higher PE minima occurred during the periods 1954-70 and 1987-2007.
    > These are what I would call Goldilocks periods. Interest rates were
    > low, inflation was largely contained and there was relatively little
    > volatility in GDP.
    >
    > So, to get to your "new normal" comment, I think that high PE ratios
    > at minima may become the "old normal" (continue the behavior seen
    > from 1987-2007) if we go into a prolonged period of economic distress,
    > whether like the depression years or high inflation years. We could
    > continue to observe PE minima above 10 if Goldilocks is not dead,
    > but simply taking a nap.
    >
    > Good question, Mike. Sorry for the equivicating answer.
    10 Sep 2009, 04:38 PM Reply Like
  • Michael Clark
    , contributor
    Comments (11721) | Send Message
     
    This PE is obscene. This reflects Ben Bernanke's commitment to his own asset valuations: the value of his own portrolio, IRA, house price....

     

    Build your boat, Noah: this liquidity is literally swamping the world, and turning the world into a swamp.

     

    The next fall is going to be three times as hard as the last fall.

     

    On May 22 02:22 PM John Lounsbury wrote:

     

    > Mike - - -
    >
    > I don't think leaving the gold standard, which started in 1971 and
    > was finalized in 1973 is directly related to market valuations.
    > The relationship is second order. The last three PE minima occurred
    > in 1974, 1982 and 1983. It could be argued that these three are
    > related to the inflation (and high interest rate) bubble that occurred
    > during that time. I will leave it to others to argue whether that
    > had a first order cause in the abandoning of the gold standard.
    > Higher interest rates tend to supress stock prices and PE ratios
    > (money goes where it is treated best).
    >
    > Two of the other three PE ratios below 10 occurred during the 1930-40's
    > when interest rates were low, but there was still economic distress.
    > The final low PE ratio occurred in 1949 following a period of very
    > high inflation.
    >
    > The higher PE minima occurred during the periods 1954-70 and 1987-2007.
    > These are what I would call Goldilocks periods. Interest rates were
    > low, inflation was largely contained and there was relatively little
    > volatility in GDP.
    >
    > So, to get to your "new normal" comment, I think that high PE ratios
    > at minima may become the "old normal" (continue the behavior seen
    > from 1987-2007) if we go into a prolonged period of economic distress,
    > whether like the depression years or high inflation years. We could
    > continue to observe PE minima above 10 if Goldilocks is not dead,
    > but simply taking a nap.
    >
    > Good question, Mike. Sorry for the equivicating answer.
    17 Sep 2009, 04:43 AM Reply Like
  • Mark Bern, CFA
    , contributor
    Comments (7337) | Send Message
     
    I am surprised we haven't seen the usual comment saying that you can't use the P/E of the S&P 500 without taking out all those companies that lost money in the last 12 months, especially banks. It is true that this ratio will improve once the Q4 2008 losses are no longer part of the equation. The banks dropped tens of billions in losses during that period due to mark to market accounting requirements. Now they can hide those losses and the need to write off bad assets is on the back burner. The hope, of course, is that housing prices will rebound substantially so the write off no longer have to occur. But the truth is that if banks' assets were marked to market today, the red ink would be flowing like tsunamis.

     

    So, have said that, the inclusion of Q4 2009 earnings (losses) will probably provide the last picture of reality we'll see for a long time.
    6 Oct 2009, 11:26 PM Reply Like
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