Macro-trends: 1) Most Americans have very little saved or invested, and they live beyond their means. 2) Any body that has applied for a home loan in the United States in the last 20 years knows first hand that the banks are willing to lend you far more than you can actually afford. 3) The U.S.A has been dependent on an influx of credit & investment for years.
My opinion is that the credit issue is not limited to sub-prime mortages and the impact will spread to other market segments - since the U.S economy is so dependent on credit. My guess is that we won't bottom till mid 2008 and the mess will take another 2 years to work it off.
and.....Read the below NY times financial article Economic Scene Remembering a Classic Investing Theory By DAVID LEONHARDT Published: August 15, 2007 More than 70 years ago, two Columbia professors named Benjamin Graham and David L. Dodd came up with a simple investing idea that remains more influential than perhaps any other. In the wake of the stock market crash in 1929, they urged investors to focus on hard facts � like a company�s past earnings and the value of its assets � rather than trying to guess what the future would bring. A company with strong profits and a relatively low stock price was probably undervalued, they said. Their classic 1934 textbook, �Security Analysis,� became the bible for what is now known as value investing. Warren E. Buffett took Mr. Graham�s course at Columbia Business School in the 1950s and, after working briefly for Mr. Graham�s investment firm, set out on his own to put the theories into practice. Mr. Buffett�s billions are just one part of the professors� giant legacy.
Yet somehow, one of their big ideas about how to analyze stock prices has been almost entirely forgotten. The idea essentially reminds investors to focus on long-term trends and not to get caught up in the moment. Unfortunately, when you apply it to today�s stock market, you get even more nervous about what�s going on.
Most Wall Street analysts, of course, say there is nothing to be worried about, at least not beyond the mortgage market. In an effort to calm investors after the recent volatility, analysts have been arguing that stocks are not very expensive right now. The basis for this argument is the standard measure of the market: the price-to-earnings ratio.
It sounds like just the sort of thing the professors would have loved. In its most common form, the ratio is equal to a company�s stock price divided by its earnings per share over the last 12 months. You can skip the math, though, and simply remember that a P/E ratio tells you how much a stock costs relative to a company�s performance. The higher the ratio, the more expensive the stock is � and the stronger the argument that it won�t do very well going forward.
Right now, the stocks in the Standard & Poor�s 500-stock index have an average P/E ratio of about 16.5, which by historical standards is quite normal. Since World War II, the average P/E ratio has been 16.1. During the bubbles of the 1920s and the 1990s, on the other hand, the ratio shot above 40. The core of Wall Street�s reassuring message, then, is that even if the mortgage mess leads to a full-blown credit squeeze, the damage will not last long because stocks don�t have far to fall.
To Mr. Graham and Mr. Dodd, the P/E ratio was indeed a crucial measure, but they would have had a problem with the way that the number is calculated today. Besides advising investors to focus on the past, the two men also cautioned against putting too much emphasis on the recent past. They realized that a few months, or even a year, of financial information could be deeply misleading. It could say more about what the economy happened to be doing at any one moment than about a company�s long-term prospects.
So they argued that P/E ratios should not be based on only one year�s worth of earnings. It is much better, they wrote in �Security Analysis,� to look at profits for �not less than five years, preferably seven or ten years.�
This advice has been largely lost to history. For one thing, collecting a decade�s worth of earnings data can be time consuming. It also seems a little strange to look so far into the past when your goal is to predict future returns.
But at least two economists have remembered the advice. For years, John Y. Campbell and Robert J. Shiller have been calculating long-term P/E ratios. When they were invited to a make a presentation to Alan Greenspan in 1996, they used the statistic to argue that stocks were badly overvalued. A few days later, Mr. Greenspan touched off a brief worldwide sell-off by wondering aloud whether �irrational exuberance� was infecting the markets. In 2000, not long before the market began its real swoon, Mr. Shiller published a book that used Mr. Greenspan�s phrase as its title.