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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:
636 Comments
T r u t h - Monday March 02, 2009 02:39PM EST
they can go to zero...with obama thats where theyre going
TylerS - Monday March 02, 2009 02:42PM EST
I predict the market will bottom at around 5.6k. It will probably hang there for some time, but it won't deviate from 5.6k too far. I might be wrong, we might see 4.8k, but I doubt it. All your commodities are in the garbage.
Yahoo! Finance User - Monday March 02, 2009 02:44PM EST
My cat says Dow 4000. But he's usually six months early. So that would be around 3500 or so.
Yahoo! Finance User - Monday March 02, 2009 02:45PM EST
Thanks Bush and Cheney for destorying our country!!!
- Monday March 02, 2009 02:45PM EST
Gov't put stalls market downfall...........amazing what our government can do...isn't it?
Dean - Monday March 02, 2009 02:47PM EST
I believe the L curve scenario is most likely...we'll crater at some crazy number far below where we are today and then just stay there for many years. I find it funny that, in large part, the U.S. financial industry created much of this global phenomena, and it will largely be the U.S. that will utlimately pull the world out of it. We are still the straw that stirs the drink, people!
John - Monday March 02, 2009 02:47PM EST
Rawzodiac is a loser. I guess you forgot your buddy Dubya destroyed this country.
chickaboom - Monday March 02, 2009 02:47PM EST
The Dollar is already worth one plastic bag----does it have to go to pellets?????!!!!!
TylerS - Monday March 02, 2009 02:47PM EST
Another point. Part of the problem with the tech boom is prevalent today. Digital currency. Ever join an affiliate program that requires you to earn a certain amount before you can cash out? Sometimes those assets are never cashed out, but they still account for something.
J - Monday March 02, 2009 02:48PM EST
Thanks for today's "Punch in the Stomach". Do you have anything good to say?
Neal G - Monday March 02, 2009 02:49PM EST
You can t keep on supporting company who is burning our money faster than they take it from the government. I hate to say it. Let them go out of business. We are going to be paying the price. The tax payer will pay more taxes. The snow ball is getting bigger by the second. You need to get the fact straight. This all started when Clinton was in office forcing the banks to give loan to people, who werent qualify for loans. The greed of speculator made the real estate go right through the roof. The United States need to protect the American people and stop giving tax break to big corporation, who out source American jobs oversea. You need to downsize Fed and State employees. They need to do more jobs and they need to get American back on track. The automotive industry stop making good cars in the late 80 s. The union are too greedy. The American people should take a job and work for Honda and Toyota. They treat their employees right and will have a job for the long haul. The Union keep on asking for more and more. The hell with the Union.
P - Monday March 02, 2009 02:52PM EST
you morons calling for dow 4000 will have your ass handed to you
Yahoo! Finance User - Monday March 02, 2009 02:54PM EST
As Long as Obama continues to talk everything down and make threats to our Banks and Businesses the markets will continue to tumble. Times like these it would be great to have a real leader in office
Yahoo! Finance User - Monday March 02, 2009 02:55PM EST
i think market vil fall down to 5x PE...
Yahoo! Finance User - Monday March 02, 2009 02:55PM EST
I'm buying various indices like the S&P 500 regularly. Buying with the intent to hold at least 20 years. I believe I'll have a lot of money as a result.
Yahoo! Finance User - Monday March 02, 2009 02:55PM EST
I'm buying various indices like the S&P 500 regularly. Buying with the intent to hold at least 20 years. I believe I'll have a lot of money as a result.
Eileen - Monday March 02, 2009 02:56PM EST
Bush is not responsible for this mess. The democrats who forced Fannie and Freddie to give mortgages to people who had no business owning a home are the ones to blame
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Yahoo! Finance User - Monday March 02, 2009 02:38PM EST
WELL it's that time again 2:30pm.......... time for the treasury - (Govt.) to dump in billions on the Market SO.............. the market goes back up.