Another day, another crash. Retailers and credit card companies have joined builders, mortgage lenders, financial services firms, and newspapers, in the toilet. Almost everyone in the country except News Corp’s Peter Chernin and CBS’s Les Moonves has concluded the economy’s already in a recession. The Dow’s down another 300.
So how far could stocks drop?
Unfortunate answer: A long way from here.
We’ve addressed this question several times over the past few months. Below is a summary of our reasoning in November. (Also, every time we publish one of these gloom and doom pieces, the market promptly jumps a couple of hundred points, so maybe if we publish again now, we’ll save the weekend).
Normal Crash = 30% (Dow 10,000)
According to John Hussman of the Hussman Funds, a dime-a-dozen bear market, which we get about once every 5-10 years, takes stocks down about 30%. For reference, this would put the Dow around 10,000 at the trough. In more severe bear markets, the kind we get every 30 years or so, stocks drop about 50%, which would put the Dow around 7,000 (yes, we just had one of these. Hopefully that will insulate us, but probably not). In the most severe bear market to date, 1929-1932…well, you don’t want to hear about that.
Why We Suspect We’re Screwed
*Stocks are still very expensive by valid historical measures (emphasis on “valid”–see below).
*Our economy appears to be headed into the tank.
*It is easy to see how we could “get there from here.”
1. Stocks are still expensive.
By one of the few valid measures of value–cyclically-adjusted P/E–stocks are still very expensive. Specifically, the S&P 500 still trades above 20-times “normalized” earnings–meaning earnings computed using the average profit margin over the past half-century.
(Don’t let your broker persuade you that stocks are now “cheap” because they’re only trading at 15-times earnings. First, that’s not “cheap”–it’s average. Historically, stocks have spent about half the time below 15 times earnings, sometimes far below, and contrary to another thing your broker will tell you, the level of interest rates is irrelevant. Second, today’s corporate profit margins are still near all-time highs, which means that P/E multiples look artificially low. Unless you believe that, for the first time in history, profit margins are going to remain at all-time highs, you should calculate price-earnings ratios off “cyclically adjusted” earnings.)
2. Our economy appears to be headed into the tank.
Just read the headlines every day. Or this summary.
3. It’s easy to see how we could get there from here.
In recent years, our economy has been driven by “virtuous circle” of rising home prices, increasing net worth, and strong consumer spending. That virtuous circle is now reversing into a vicious cycle of dropping home prices, decreased home-equity withdrawals, and reduced consumer spending. It’s possible we could be getting close to the bottom of that spiral, but I doubt it.
You Work at A Small Private Company–So Should You Care? Yes.
Anything that happens in the public market will affect the private market, so don’t think that just because you work at a small private company you’ll be immune. Also, don’t think that stocks will just tank independent of economic weakness (if they do, they’ll just pop back up). If we’re headed into an ugly bear market, it will be because the economy’s fundamentals are breaking down, so you’ll find regular old business tougher, too.
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