Europe’s down about 6%, Japan fell 4%, and Dow futures are down 350 or so. Still 24 hours before the market opens, so plenty of time for a (temporary) bounce, but regardless of what happens tomorrow, it’s increasingly clear that our credit-fuelled dream years are rapidly coming to an end.
Hard to say which would be worse: A sudden 2,000-3,000 Dow drop to the past century’s average valuation level*–or a grinding, gut-wrenching slog of head-fakes, dashed hopes, and ever-spreading depression. Either is possible (as, we suppose, is a sudden recovery, but we’re hard-pressed to find a fundamental explanation for that one).
*Your broker, like one of ours, is no doubt excited to report that stocks are now a great buy because the S&P 500 P/E is now about in line with the long-term average of about 15X. There are a few problems with this analysis.
- Profit margins are still at a cyclical high. When they regress to the long-term mean (which they will unless “it’s different this time”), earnings will drop, and the P/E will look much higher.
- Your broker is almost certainly referring to “forward operating earnings,” which are quite different than trailing actual earnings. That 15X “average” multiple is based on the latter. The long-term average multiple on forward earnings is lower.
- “Operating earnings” don’t include all the massive write-downs firms are being forced to take as they realise that their balance sheets are overloaded with crap.
- “Average” does not mean “cheap.” The reason 15X is the average is that stocks have spent about half of the last century below that number. “Cheap” would be about 10X.
- Interest rates are irrelevant. Yes, there has been a recent correlation between interest rates and P/Es, but extend your analysis back more than 10-20 years, and the correlation disappears.
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