The Big Picture: How Cheap is the Market?

Barry Ritholz notes that the market is no longer terrifically expensive:

The Big Picture: How Cheap is the Market?: The answer might surprise you. It certainly raises some very interesting questions as to what cheap is, the importance of having a long term perspective. It also begs the question of how much patience long term investors have when it comes to thinking about various metrics. The question itself involves a combination of data analysis and opinion. To fully explore this issue, we will listen to two different perspectives on the subject: One says the S&P500 is cheap, the other asks, how much cheaper might it get?

For part one, we go to Eddy Elfenbein of Crossing Wall Street: Eddy observes "S&P 500 is now trading at just under 16 times trailing operating earnings. The P/E ratio hasn't been this low since October 1995." Note that he references actual trailing earnings. This is more accurate than using forward forecasts, which tend to be very wrong at key turning points...

Comments

[anne]

The yearly return for the S&P stock index since January 2000 has been about 1%, corporate profits however have been excellent save for the brief recession period, also the S&P regularly replaces weaker corporations with stronger. So, valuation have come to attractive levels no matter whether the market falls or rises for a while.

[a different chris]

Well, it got a hella lot cheaper today that's for sure.

[old ari]

I'm sorry to see "Begs the Question", go the same way as a "Long shot", what's next "Sticky Wicket", to mean a hard to open gate.

[David Yaseen]

I think Barry is here noting that Eddy Elfenbein believes the market is no longer terrifically expensive. In Part 2 [http://bigpicture.typepad.com/comments/2006/05/how_cheap_is_th.html], he gives the floor to Scott Frew:

"To my view, the big issue is not why the market has fallen over the last several weeks, but rather how it has managed to stay as elevated as it is for as long as it has.
...
The chart below is taken from Robert Shiller’s website, and uses trailing ten year earnings in order to adjust for the fact that we are, at the moment, in a period of unusually high earnings. As you can see, the market only looks cheap when compared to the previous peaks in 1929 and 2000. This does not bode well for future returns."

For his own part, Barry is on record [http://www.forbes.com/markets/2006/03/03/robert-lenzner-streettalk-cx_streettalklander.html] predicting that the Dow will end 2006 at 6,800...

[anne]

Oh dear, and here I was being complacent :) Diversify, diversify.

[anne]

This market, and well as Europe's market, by the way, has been right for fine value investing for years. The lack of gain in the S&P stock index or somewhat better gain in the Europe index has masked fine gains for investors attending to value.

[derrida derider]

old ari, I think most Americans would think a "sticky wicket" WAS a hard to open gate, rather than a moist cricket pitch on which the ball spins unpredictably (and is therefore very difficult for the batter - hence "playing on a sticky wicket" is being in a difficult predicament).

And I think most people do use "begs the question" as synonymous with "raises the question". A pity. It's like "I refute that assertion" being taken as "I deny that assertion". Verbal chisels - terms with a precise and useful meaning - are being used as screwdrivers. What then do we do when we need a chisel?

[Maynard Handley]

"The Market" --- that would be the US stock market, huh? The one denominated in dollars? The same dollars that you predict, in a post about three up is destined to fall, perhaps rapidly, perhaps not, but fall?

Given this, and given that the entire world pretty much moves in sync nowadays, the question of interest is not whether the US market in dollars looks cheap, but what the expected returns are, relative to the expected returns from the competitors (Europe/Asia/Developing) that are not denominated in dollars.

[kharris]

Maynard,

Too extreme. Excluding valuation in dollars doesn't make sense. Considering valuation in dollars and in other currencies makes sense.

[Barry Ritholtz]

Be sure to se part II, which notes that "Just because its cheap, dont mean it cant get cheaper!

http://bigpicture.typepad.com/comments/2006/05/will_cheap_stoc.html

[Scott Teresi]

This analysis is ignoring a couple important factors. The market appears cheap because earnings are at their peak right now in the business cycle. But normally, the market is much cheaper than this when it reaches an earnings peak.

At least, this is what John Hussman says in his Weekly Market Comment, here: [http://www.hussmanfunds.com/wmc/wmc060320.htm]. He runs the excellent hedge fund Hussman Strategic Growth.

Scott