If there’s any good news in the global stock market collapse it is this: he farther the market falls, the more confident long-term investors can be that they’re going to get a compelling return.
After nearly two decades of being overvalued, US stocks are finally approaching fair value, which is about 900 on the S&P 500, according to a cyclically adjusted P/E analysis. If past is prologue, this pricing should yield a long-term return of about 10% per year.
The chart from Andrew Smithers below shows the S&P 500 vs. cyclically adjusted earnings through March. The S&P 500 price is obviously out of date (1,361 vs. today’s 996), but the earnings trend line, which averages 10 years of trailing S&P 500 earnings, is similar. Background on cyclically-adjusted P/E and below.
The bad news, of course, is that “fair value” is fair value because stocks have historically spent half the time below that level, as is clear in the chart. So we may have to wait a while to get that 10%.
Have Stocks Hit Fair Value Yet?
Henry Blodget [Sep 18, 08 6:34 AM
Has the 800-point drop in the DOW this week made stocks cheap? Unfortunately, no. But the good news is, after years of being significantly overvalued, stocks are finally approaching fair value.
A chart from Andrew Smithers, a London-based strategist, explains:
What is the chart showing you? The S&P 500 relative to the only two valuaton measures that have been shown to have predictive value over long periods of market history: cylically adjusted price earnings ratios (CAPE) and “Tobin’s Q.”
Cyclically adusted earnings ratios adjust for the business cycle by “normalizing” corporate earnings to average profit margins (as opposed to the record-high margins of recent years). Tobin’s Q, meanwhile, is an estimate of business “replacement value.” In the past, stocks have gravitated around these measures, often with multi-decade swings above or below the long-term average.
As Smithers’ chart shows, stocks have been “expensive” on CAPE and Q measures since about 1990. Now, thanks to the market’s recent collapse, they’re getting back toward average levels (about 900 on the S&P 500).