Go ahead and buy stocks, says John Mauldin–if you’ve got a 10-year time horizon. If you don’t, don’t. Because it’s just another sucker’s rally.
(We agree with John’s logic. As you can see here and in the chart above, the three massive bubbles like the one we just had ended with the market bottoming at a 5X-8X P/E, so we’ll probably get there this time, too. It’s always possible that it will be different this time, though. Especially given the mind-blowing amount of money the government is printing. That’s why we keep emphasising that, if you do have a 10-year horizon, stocks are finally moderately cheap.)
Barron’s probably jinxed the stock market by stating why they think the Dow won’t fall to 5000, although we do have what I hope is the start of a nice bear market rally. Part of their reasoning is that stocks are cheap. They assign a price to earnings (P/E) ratio of a lowly 13, based upon 2009 estimated earnings of $51 in operating profits, which they suggest is historically low. And I agree that 13 is toward the low end and would represent a good long-term buying opportunity – if indeed it was 13.
Actually, if you want to get really bullish, go to S&P’s web site and look at their estimated earnings for 2009. They calculate a P/E of 10.89 on 2009 estimated operating earnings.
As I have written over the years, the long-term P/E studies all use “as-reported” earnings, or earnings that are reported on tax returns. Operating earnings are of the EBBS variety, or Earnings Before Bad Stuff (or whatever you want to designate as the BS component). Companies like to tell us to ignore all those “one-time” writedowns, which seem to happen a lot more than once these days.
Going back a few decades, operating and as-reported earnings were very closely aligned. That relationship began to change in the mid-’90s, as management wanted to make a more bullish case, which certainly helped with their stock options. And the difference between operating and as-reported earnings is now wider than ever.
The difference between estimates for 2009 operating and as-reported earnings is almost exactly 100%. Which means that analysts are projecting there is going to be a lot of Bad Stuff in 2009 to be written down. The table below is a cut and paste from the S&P web site, where they calculate the earnings for the S&P 500. Notice the difference between the P/E ratios for operating and as-reported earnings. The latter P/E is based on the previous 12 months and used Thursday’s price, so if you calculate it today it would be slightly higher.
Did you notice the as-reported estimated earnings P/E for the quarter ending September 30, 2009? In the 20 years of data on the web site, the highest it ever got to was 46, in the last recession. That P/E of 181 is because of the negative earnings for the 4th quarter of 2008. Of course, this assumes that earnings estimates don’t keep being revised downward, which is not a safe assumption. They have been revised downward every quarter for almost two years. Seemingly, past projections are not indicative of future results.
Now, to be fair, using the extremely bad earnings of the recent past as a one-time metric is not altogether indicative either. Robert Shiller of Yale uses 10-year average earnings to smooth out the business cycle, and this would give you a P/E of about 13.
My good friend Ed Easterling uses a different methodology to project earnings, involving the historical relationship between GDP and P/E ratios. This is based upon the historical fact that earnings more or less rise at the level of GDP plus inflation. This is a mean-reverting chart, as earnings cannot grow faster than GDP for too long, and also acknowledges that rough patches like the one we are in now will not last, and earnings will rebound. Using his methodology we end up with a P/E just south of 13.
So, I know a lot of you have stayed in the market the whole time it has been falling and are now wondering what to do. If you have a 10-year time horizon you probably can buy here and do OK. But I wouldn’t. I think this market is going to have more problems as we confront the real possibility that we will get some really poor earnings for the first and second quarters. The economy is simply weak, and that weakness is hitting more and more companies. From exporting companies to the big international firms, a global slowdown is hitting almost everyone. Even hospitals are being challenged. We could see a real bear market rally lure investors back in, just to crush their hopes this summer.
Markets go from high valuations to low valuations and back again over long periods of time. I believe that we have a long time to go in the current secular bear cycle. As I have written for years, this one began in 2000 and could last until the middle of the next decade. While we will see a “bottom” in stock prices at some point, maybe even this year, we have a long way to go to get to a really low P/E ratio.
Big secular bull markets happen when P/E ratios drop below 10 (and even lower). That acts just like winding a spring. When it is let loose, it explodes for a very long time. There is another bull market in front of us. I would rather be patient and rely on an absolute-return style of investing for now. If I miss the first part of this run, so be it. I see more risk than reward in this latest run-up.
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