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From The Business Insider, March 2, 2009:
There were four massive stock bubbles in the 20th Century: 1901, 1929, 1966, and 2000. During each of these bubble peaks, the S&P 500 neared or exceeded 25X on professor Robert Shiller's cyclically adjusted P/E ratio.* After the first three of these peaks, the S&P 500 PE did not bottom until it hit 5X-8X. We're still in the middle of the last one.
The most recent bubble peak, 2000, was by far the most extreme we have ever experienced. In 2000, the S&P 500 by prof. Shiller's measure exceeded 40X (it had never before exceeded 30X). With the S&P 5000 hitting 700 today, the PE has now fallen back to 12X. (See chart above.)
Three major bubbles are not enough historical precedent to confidently conclude where the S&P 500 will bottom this time around, but it seems reasonable to conclude that the trough will be in line with--or below--the preceeding lows (Given that we just had the highest peak in history by a mile, it doesn't seem absurd to think that we might be headed for the lowest trough in history by a mile.)
So where are we now?
Based on Professor Shiller's latest numbers, we're at about a 12X P/E. (Prof. Shiller's last update was at 805 on the S&P 500, which produced a 14X P/E. Plugging in today's 700 on the same earnings number, we get about a 12X P/E). The 12X PE compares favorably to the long-term arithmetic average of 16X, but it's still way above the historical troughs of 5X-8X.
So where would the S&P bottom if we hit the previous trough PE lows? It depends how we get there.
If the stock market stops falling and earnings eventually begin to grow again, we would be close to the bottom: The market could simply move sideways for 5-10 years while earnings growth gradually reduced the PE to the 5X-8X range. This is what happened in the 1970s.
Alternatively, the market could just keep dropping, as it did in the early 1930s.
Using Professor Shiller's latest earnings data, here's where the numbers would fall out if the market just kept dropping and 10-year average earnings didn't grow from today's level:
P/E S&P 500 Level
10X 575
8X 460 (highest previous trough low)
7X 400 (average previous trough low)
6X 350
5X 300 (lowest previous trough low)
In short, if the S&P fell straight to the high-end of its previous trough range (8X PE, or 460), it would fall another 35% from today's level (700)
If the S&P fell straight to the low-end of its previous trough range (5X PE, or 300), it would fall another 55+% from today's level.
Here's hoping we don't set a new low on the downside.
* Shiller's "cyclically adjusted" PE takes an average of 10 years of S&P 500 earnings instead of using a single year's. Why? Because the business cycle makes single-year earnings misleading. In boom times, profit margins are high, and P/Es look artificially low (and stocks look misleadingly cheap). In busts, profit margins collapse, and P/Es look artificially high (and stocks look misleadingly expensive--as is the case this year). Shiller's cyclically-adjusted PE mutes the effect of the business cycle and, therefore, provides a much more informative and predictive PE ratio.
Here's a link to Professor Shiller's site, where you can download an Excel spreadsheet with all of the S&P 500 data.
More coverage from The Business Insider:
Brad - Monday March 02, 2009 02:59PM EST
"Thanks Bush and Cheney for destorying our country!!!" All this crap really started during the Clinton Administration. Clinton wanted to afford everyone an opportunity to own their own home. Mortgage companies and banks jumped on this bandwagon and started offering loan vehicles such as the option ARM. This allowed people to get into much more home that they could really affort. When thier principle got upsidedown to about 110% of the original loan amount these people had to try to refinance but in many cases this meant forclosure and this trend has continued. As a result the lenders finally tightened up, sub prime loans were impossible to get so the people who's credit was damaged so bad because they got behind in these bad loans had nowhere to go but forclose. thanks to Bill who really got this ball rolling!
ken - Monday March 02, 2009 02:59PM EST
By end of second quarter 2010 dow should be over 10,000
Pat G - Monday March 02, 2009 02:59PM EST
401k accounts have skewed the stock markets for 25 years now. In fact the housing bubble did not start in 2002 - It started way back in 1982. With 401k getting highly unpopular, we are entering territory where teh S&P will now line up with the historical trendline meaning it could head back to as low as 250-300. Market prices had little to do with fundamentals and more to do with people pumping in money every 2 weeks causing the irrational bubbles we saw so frequently. Same theory applies to commodity bubbles.
JustinT - Monday March 02, 2009 03:00PM EST
And now Best Buy is getting in on the corruption. Just when you think you've picked a winner! Yea, what a winner...more of the same.
Paul T - Monday March 02, 2009 03:00PM EST
It will continue to go lower until the government provides incentives to companies that retain workers. If all companies are going to do to get ahead is cut jobs then the money isn't going to move and the snowball effect is going to continue.
Yahoo! Finance User - Monday March 02, 2009 03:00PM EST
Obama didn't ask WalMart to move into your neighborhood. He is for the worker. Dow 4000 has no impact on most US citizens. Many of us group up with very little and continue to do so. The Union is our last hope. They won wars for us, and they will get us out of this mess.
Yahoo! Finance User - Monday March 02, 2009 03:00PM EST
Yep, what we need is mor government...They can help. Let's print more money and bail more people out! Yep, the government has the answer!
Kevin - Monday March 02, 2009 03:01PM EST
Roll Dow Roll, Around the bowl and down the hole. Roll Dow Roll!
Yahoo! Finance User - Monday March 02, 2009 03:01PM EST
close the casino, president obama. let the americans work and no more gambling!!
Realist - Monday March 02, 2009 03:01PM EST
There's enough blame to go around. It's amatuer hour at the Obama administration. Spending $800 Billion on BS and calling it a 'stimulus'. I don't know about you guys but I've never been hired by a poor person. Stop validating this debacle with the "Bush did it first" arguement. You come off sounding like 1st graders. Hope and Change? I Hope I'm left with some Change. What a disaster!
Deborah - Monday March 02, 2009 03:02PM EST
jj12544 - Monday March 02, 2009 02:48PM EST Thanks for today's "Punch in the Stomach". Do you have anything good to say? Ummm, sorry-are you that depressed that you always need "something good to say"? Life is not about "good times only", but we make it through the marathon. I hope you can handle a bad economy, as that is what is in store-Be strong, and "suck it up", as we have no choice-remember-whatever doesn't kill us makes us stronger
Concord Carpenters - Monday March 02, 2009 03:02PM EST
I really enjoy reading the negative comments, especially when people can't spell. "...for destorying our country!!!"
PS - Monday March 02, 2009 03:02PM EST
Reckless spending by Bush. Reckless wars courtesy of Bush. Reckless bankers Reckless politicians Reckless lawyers Good luck America with criminals at the helm. Baby Boomers work until you are 80. Your pension and your house have become worthless.
Fault Guy - Monday March 02, 2009 03:02PM EST
I would like to see the market at 00000. Why should some lazy s.o.b.'s get rich off of MY hard work? Investors are nothing but leeches. They do NOTHING to make a company successful. They aren't in the cubes writing code. They don't answer phone calls from angry customers. They don't make the products. They don't sell the products. They don't fix the products. They just give a little bit of their money and hope to get more money back. What a crock. Hey, if you investors have so much money that you don't know what to do with it...how about giving it to me?? I could use some more.
siegis - Monday March 02, 2009 03:03PM EST
To all those whackos attending the CPAC convention: So tell me who is re-distributing the wealth now????? $ 11.4 TRILLION lost in pensions,annuities and retirement savings of the middle class. Thanks for your wonderful conservatorship of America's wealth and financial prowess.
STORMSTOCKER1 - Monday March 02, 2009 03:03PM EST
HEY HANK N AARON, don't you listen to your guests? The stock market is "not cheap" if the earnings are not there.ie.P/E.? This Price/Earnings ratio based on forward earning is still indicating the market has a "deeper hole" to go to. Besides earnings, What about the world bank problems, ...we are just seeing the "tip of the iceberg" here with Iceland, Ireland,Latvia,Turkey, etc.etc. all "going to the World Bank for a handout, that is not there...... HERE IS WHAT WE NEED AND WE NEED IT RIGHT NOW. FOR OUR NATIONS ECONOMIC STIMULUS.......... 1. CUT ALL INCOME TAXES BY 50%, 2.CUT ALL PROPERTY TAXES BY 50% 3.CUT ALL SALES TAXES BY 50% 4. CUT ALL CAPITAL GAINS BY 50% Then VOTE THE BUMS OUT OF OFFICE IN THE SENATE!!
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Boris B - Monday March 02, 2009 02:58PM EST
Buy GOLD ,forget inflated US Dollars.This is the end of capitalistic system and US empire.US need a war.