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March 11, 2010
This article was published a couple of days ago. It is essentially an article that rehashes an argument about the correct way to value the stock market between two old economist friends, Robert Shiller and Jeremy Siegel. It goes without saying that Jeremy Siegel doesn’t (and hasn’t really) impressed me with his opinions. The gist of the article uses the Shiller PE ratio we’ve written about recently.
Note the one difference that we use in calculating the average Shiller P/E ratio versus the article’s graphic. Instead of including the bubble prices of the late 90s and early 00’s, we exclude them completely to calculate how the stock market is “normally” valued. Instead of an average of 16.4x earnings, we see average as closer to 15x earnings.
If the market were to revert to just its average valuation of 15x, it would need to fall 25%-30% from here. This is backed up by valuing the market based on corporate profit margins as well as current asset-replacement values such as the Tobin Q ratio. In other words, it isn’t just one measure that shows the potential for losses from here. They all arrive at similar conclusions.
And, stock prices in bear markets can and do fall below their average valuation. That’s how bear markets work. The low was registered at about 670 for the S&P 500 in March 2009 – one year ago. A 25-30% drop back to fair or average value based on the past 10 years earnings would bring the market back to 850 or so. That turns a 70% into only a 25% rally. This is not a prediction, just a worry and a wonder that we’re acting upon. We aren’t betting on it, we’re just trying to avoid it the best we can.
At the very least, valuations as stretched as these act as a weight on future returns. This article, "Worries Rebound on Bull's Birthday" sums it up nicely.
March 10, 2010
We ran across this article in the NYT. As we mentioned in our latest commentary, this article addresses the issue of public pension plans and their investment return assumptions going forward. Click here to read the NYT article. Also, for those interested in digging even deeper, this is the Pew Center’s recent study of the financial status of public pension plans across the country.
