23 Responses to “Do P/E’s matter?”

1. PEJ
   September 3rd, 2009 at 5:42 pm

   

   I think since the Greenspan Put, equities have been in bubble. but the current PE is the biggest in history which means that Bernanke has been able to do a far greater achievement than Greenspan already!
   You can have a look at the chart here and see that the P/E started to trend above the historical average around 1980 to reach 2-3 bubble figures and never ever go below its historical average:
   http://realitylenses.blogspot.com/2009/08/new-historical-record-on-s-500-per.html

2. Mike
   September 3rd, 2009 at 5:46 pm

   

   That’s a good chart you have. It’s going to be painful getting back to 7.

3. PEJ
   September 3rd, 2009 at 5:50 pm

   

   At the current level of earnings, the S&P should be trading at 50 (no typo) for a PE of 7.
   Even if earnings double, you would be 100.
   It’s really hard to believe those numbers. I can’t even believe that myself… but the Dow in 193x and the Nikkei this year, show that it’s doable.

4. Mike
   September 3rd, 2009 at 6:00 pm

   

   Well, that includes the $23 loss in Q4. To be fair, you can leave that out and go by Q1 and Q2, which were 7.50 and 13.50, respectively. I think for 2009-2012 we’re going to be conservatively looking at $20-40 per year in earnings. That’s about the level of earnings from 1988 to early 1999 and from 2001 to 2003, basically the recent US economy during good times but not blow-off manias (earnings were higher in late 1999-2000 and 2004-2007). Look at S&P’s earnings file here:
   www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS

   So with a PE of 7 the target is 140-280 on SPX. With a PE of 15, you’re talking 300-600. Obviously, new lows are in order… the question is just how low and when.

5. PEJ
   September 3rd, 2009 at 6:24 pm

   

   yes agreed. Though with the CRE implosion, nothing is given in terms of earnings.

6. Mike
   September 3rd, 2009 at 6:27 pm

   

   Agreed. And it’s not just CRE.

   Much lower future earnings figures should be entertained, even if not traded on.

7. PEJ
   September 3rd, 2009 at 6:32 pm

   

   In the meantime, gold is at a haircut from its historical high as well.
   Interestingly, you and I agreed that gold should fall in $ terms during deflations, but Robert Prechter disagrees!

8. Mike
   September 3rd, 2009 at 6:37 pm

   

   I’m not counting out a couple more days of blow-off in gold and silver, though with bullishness at extremes already, this should be a terminal move.

   Prechter, from everything I have read, and I follow him closely, is bearish on the metals from a nominal point of view, though somewhat ambivalent since he is a gold bug at heart and expects gold to be an absolutely necessary element of surviving the full course of this depression.

9. PEJ
   September 3rd, 2009 at 6:45 pm

   

   oh and you’ll be happy to read that i’ve ordered his socionomics books (i’ve finished the elliott wave one and the conquer the crash, need to read the crest of the tidal wave)

10. Matt Damon
    September 4th, 2009 at 10:47 pm

    

    “I’m not counting out a couple more days of blow-off in gold and silver, though with bullishness at extremes already, this should be a terminal move.”

    LOL! You’ve been saying this since Jan this year. How many times in a row do you have to be wrong to finally admit that you were. Admit that either you or Prechter doesn’t “get” the PM market. Repeat after me - “I was WRONG”.

11. Aki_Izayoi
    September 5th, 2009 at 8:56 am

    

    On a trading note, I actually though the best risk/reward for a short would come in August because sentiment was so bullish, and many people for calling for a collapse in September. From a trading perspective, that was a good call a priori, but it didn’t happen. It was still a good risk/reward bet from the past perspective, although it wasn’t a lucrative bet because it didn’t happen. Now, I see a New York Times article warning about a possible sell-off. Remember, TRADING PROFITS ARE VALUABLE BECAUSE THEY ARE SUPPOSED TO BE SCARCE (as they are derived in a zero-sum competition and traders have their own pride and egos that they also seek relative performance at times - therefore it is impossible for everyone to do relative well, and everyone can do well absolutely if there is more money flowing in the market to bid up asset prices, but the latter case does not apply to other markets where a long position has to be offset with a short position); if everyone is positioned for a collapse or hedged to protect against it, it is unlikely that one can profit off of it. In hindsight, one cause easily predict that July rally if one knew how many people were short.

    On a short term perspective, I do not like short equities… it seems too many bears on Seeking Alpha hate equities (many of these equities bears are also China bulls, dollar bears, commodity bulls, and precious metal bulls) and it seems that talk about the Fed manipulating the market has somewhat ceased. However, it seems that the bear market is ending… I heard of sell-offs on “good” news. Perhaps, it is better for one to place bets in short term interest rates, bond, commodity, and currency markets where the deflationist can truly be a contrarian.

    Do you think investors realize the existence of a “Bernanke put”? Paul Tudor Jones argues that one reason for the rise in the markets is that investors realize that the government will prevent financial armageddon (the investors do not think government intervention will lead to prosperity, but it will prevent armageddon so it is similar to a put.)

    “Policy initiatives targeted at eliminating tail risks have successfully reduced risk aversion and risky assets have rallied almost across the board, reversing some of the large wealth losses suffered by global consumers. To be sure, many doubts remain about the sustainability of this recovery, most prominently the weakness of household income growth, and the damage inflicted by the crisis to potential growth in many countries will likely deliver a recovery that will look subdued by the standards of the past decade.”

12. Aki_Izayoi
    September 5th, 2009 at 9:03 am

    

    Perhaps this is one reason why gold hasn’t risen. I do not know about rising gold prices, but it seems that the current bullishness and “consensusness” of gold puts a cap on its price. If you like gold, you are now considered a sage with “unique” insights about the nature of wealth, money, and inflation. (Hugh Hendry admits that these characteristics are not conducive for a bullish case on gold) I thought some good longs come from betting on pariah assets (like bank stocks in March 09 on short term technicals and sentiment.) Regarding my long term view on gold… I could image it falling nominally (although below $700 is extremely hard for me to imagine; I could easily imagine the low $800s though), but I do agree with Adam that the relative price of gold vs. stocks will fall.

    On a similar note, Edward Harrison of Credit Writedowns who said he was sympathetic with the Austrian school has some posts advocating government intervention.

    Regarding, Mike’s bearish position on gold… we do have to admit that we can be wrong in forecasting the direction of the market. We need to be humble to acknowledge that we are wrong when we are wrong, and that many of our own predictions would be wrong. However, one can try to overcome this from a trading perspective by structuring trades that if you are wrong, you do not lose much, but if you are right, you make a lot. Sentiment and technical analysis helps in this regard, and also knowing history and personal experience so one would know how to trade a blow off phase correctly.

    “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much money you lose when you’re wrong.”
    -Stanley Druckenmiller

13. Aki_Izayoi
    September 5th, 2009 at 9:18 am

    

    I wonder how popular the “better-than-expected” earnings (or economic statistics) trade is on now. I suppose it is unwinding due to the market selling off on good news sometimes, but bearishness went up too fast. We need bullishness to persist in order to get some people to buy during the sell offs.

    My working hypothesis is that the market is the market would sell-off when it becomes unequivocal that earnings estimates are overstated. I suppose a nice dollar rally would be enough to cause an equity sell-off as this would reduce earnings in dollar terms. We should also note that the global equity markets are a keiretsu; about 40% of S&P earnings are foreign and are from all regions of the world. This is also one reason why correlations are higher and diversification is hard.

14. Aki_Izayoi
    September 5th, 2009 at 9:25 am

    

    “The weekly AAII measure of sentiment continues to reflect a repentant US retail investor. This week the bulls were unchanged at 34% while the bears increased 9% points to 49%. This is a very abrupt change as it was just 4 weeks ago (Sentiment Overview: Week Of July 31st, 2009) that we had the mirror opposite with 48% bulls and 31% bears. And it was only 2 weeks ago when we saw 51% bulls! This is especially meaningful as the market is actually trading higher ”

    Links:
    http://www.tradersnarrative.com/sentiment-overview-week-of-august-28th-2009-2881.html (Sentiment)
    http://www.nytimes.com/2009/08/31/business/31markets.html (Some analysts call an end to rally — this is a major blow to a short term bearish case)
    http://pragcap.com/paul-tudor-jones-on-the-bear-market-rally (The entire Paul Tudor Jones)
    http://www.youtube.com/watch?v=bl_Uiv89Tck&feature=related (Hugh Hendry on gold)

15. Mike
    September 5th, 2009 at 9:30 am

    

    Funny how nobody gets nastier than the gold bugs. And to me of all people, who would abolish central banks and allow gold and silver tender — I think that makes me a gold bug, doesn’t it? I even consistently say that Dow:Gold should fall to 2:1 or lower. But say that too many traders love gold and that it is overbought, and I’m the enemy. Sheesh.

16. Mike
    September 5th, 2009 at 9:36 am

    

    I’m not always short gold by the way — typically only silver actually, and only when DSI breeches 90% bulls. I even went long futures in July, but with extreme bullishness again I might short SI next week.

17. Mike
    September 5th, 2009 at 9:47 am

    

    Aki, I think the jury is still out on August as a major top in stocks. DSI and 20 day put/call reached 2-year extremes, and volume and breadth dwindled as the rally advanced, and junk lead the whole way. Also, the dollar is almost certainly bottoming. It is too early to abandon a long- term short position. Why would you do that if the high is still in place? Even a retest might not negate this, depending on volume, breadth and leadership.

18. Aki_Izayoi
    September 5th, 2009 at 12:17 pm

    

    There are other indicators that show a blow off phase… such as when the market is selling off on good news and the focus on financials in the latter rallies which means breadth was gone. The June sell-offs also lacked breadth.

    However, my objections are based on sentiment. I do not like the NYTimes article. Since a link from a sentiment site didn’t go through because I posted a lot of links in that comment, I’ll post what I found on sentiment:

    “The weekly AAII measure of sentiment continues to reflect a repentant US retail investor. This week the bulls were unchanged at 34% while the bears increased 9% points to 49%. This is a very abrupt change as it was just 4 weeks ago (Sentiment Overview: Week Of July 31st, 2009) that we had the mirror opposite with 48% bulls and 31% bears. And it was only 2 weeks ago when we saw 51% bulls! This is especially meaningful as the market is actually trading higher ”

19. Max
    September 5th, 2009 at 12:43 pm

    

    Mark Hulbert noted that gold sentiment is surprisingly lukewarm among the goldbugs he monitors. So if I had to gamble (which I don’t and won’t!), I’d gamble on gold blowing through the old highs. The experts are always wrong!

20. PEJ
    September 5th, 2009 at 2:02 pm

    

    Aki_Izayoi, what are your sources for DSI? I just read from Babak on his post today on traders narrative:

    The Daily Sentiment Index from Jake Bernstein continues to show a rather frothy mood on the street. This week it was still at the elevated levels from last week (88%) while the Nasdaq futures traders were equally optimistic at 87%:

21. golfBoy
    September 6th, 2009 at 10:44 am

    

    Just speculating: maybe gold will gain from an initial flight to safety as P3 gets rolling… then the “all the same market” effect will kick in during the latter stages of P3, just as it did in wave 3 of P1.

22. Aki_Izayoi
    September 6th, 2009 at 8:52 pm

    

    I think many investors are already positioned for gold’s advance during a general decline in the equity market.

    Does anyone have any information about the composition of precious metals (and yes, this includes “paper gold” and PM mining equity too) in investor’s (aggregate) portfolios? I supposed it has increased so they are already positioned for it. I also hypothesized that gold would do relatively well in this environment, and I heard that the Chinese government is encouraging people to buy PMs. The Chinese have the perfect investor profile for one to hold gold (e.g. a low long term intertemporal discount rate considering that they are savers.)

23. craig
    September 16th, 2009 at 8:21 pm

    

    it depends how closely Earnings approximate sustainable Free Cash Flow. If FCF is materially less than earnings, then earnings and PEs matter less. If company A has EPS of $1 and sustainable FCF of $1 a share, then its PE matters….If company B has EPS of $1 and FCF of $0.25, then its’ PE is far less meaningful as a barometer of valuation.