Nosebleed PE Ratios and the Greenspan Bubble Era

The market can remain irrational longer than you can remain solvent - John Maynard Keynes

Continuing with the question of could the market have bottomed when we still have nosebleed P/E levels, Barry Ritzholz posted a great chart on how Greenspan/Bernanke bubble policies have elevated P/E ratios well above historical norms:

  

The dot-com bubble took off in 1994 at the upper level of normal and shot well above. (The envelope is +/- one standard deviation of normal.) We briefly touched the upper envelope in Mar 2009 and then took off again. 

Most likely explanation for elevated PEs since 1994 is the excessive credit promoted by Greenspan and continued by Bernanke: elevated stocks are due to easy credit. Credit tightened at the two peaks and then was radically loosened at the two bottoms, in 2002 and 2009.

Normally any bubble returns to its start point, which still points to a true bottom at around Sp400. If earnings generally increase, the bottom should increase with it (ie the envelope is modestly rising), but the recent period of depressed earnings have turned this slow growth back down in 2009. 

Implication is: we do not fall to normal until the easy credit abates. Timing looks like 2011, as Bernanke seems likely to exit very slowly this year. Hence: 

Paradox of Recovery: when the private economy really shows signs of recovery, not just government life-support, easing will ebb and equities will fall

Comments

[cc]

Yes. Just what I need. A tax credit to hire someone, to sell to someone else, who doesn't have the money to pay for it. That's the logic which is backward to the notion of FREE ENTERPRISE.

[Mista B]

A logarithmic graph would be more illustrative, though the numbers are what count. P/E ratios are going to come down. They're already doing so with respect to private companies. I work in public insurance broker M&A land. A public broker trading at 15x EBITDA could previously afford to acquire a private agency trading at 8X EBITDA. Now that the public brokers trade at 8X EBITDA, they'll be looking to acquire at the much more historically normal multiple of 5X EBITDA. The simple fact is that margins are getting squeezed--clearly at the individual, small company, and government level. It's just a matter of time before it's evident for publicly traded companies. Once it is, the risk premium will start to shrink. It's inevitable. Public markets, though, are governed largely by investor emotion, not rational pricing. The average investor is not even remotely capable of comprehending company financials, thus they have no ability to determine what constitutes a fair price. This is why markets can stay overvalued or undervalued for long periods of time. Further, there's no convincing average investors of this. They've been well conditioned. "I believe in stocks for the long run" is a phrase I've heard many times. It's their substitute for analysis. Moreover, in the short run they often feel completely justified (e.g. the current rally). History has nevertheless always shown a swing around the mean. Stocks are overpriced right now. Profits need to rise substantially just for stocks to be fairly valued. Given the demographics and the debt overhang, that is far from likely in the next ten years.

[Dave B.]

Just to put things in perspective...

Currently, the estimate for earnings in the S&P 500 is around $75 per share. At the 1100 level, we are looking at a P/E multiple of 14.6

As for the poster above who claims that the markets can stay overvalued or undervalued for long periods of time because the "average investor is not even remotely capable of comprehending company financials..." this of course ASSUMES that the average investor is the one that drives stock prices.

I would suggest that the above assumption and logic is FAILED given the amount of program trading that occurs in today's equity markets . . . which is highly reflective of "institutional" activity in the marketplace.

Institutions are the ones that DRIVE the equity markets, and NOT the average retail investor.

[upstart]

Update: Stocks still perfectly mimicking early 2007 form and relationship to moving averages. Rally after the correction held above 50-day ma for a day or two, then the pullback before continuing higher. You can still see the 2007 version and its relationship to the averages on the 3-yr. chart on stockcharts.

[Chris]

"In terms of types of financial wealth, the top one percent of households have 38.3% of all privately held stock, 60.6% of financial securities, and 62.4% of business equity. The top 10% have 80% to 90% of stocks, bonds, trust funds, and business equity, and over 75% of non-home real estate. Since financial wealth is what counts as far as the control of income-producing assets, we can say that just 10% of the people own the United States of America."

Wealth, Income, and Power

by G. William Domhoff
September 2005 (updated February 2010)

http://sociology.ucsc.edu/whorulesamerica/power/wealth.html

[The Gondolier]

Didn't Prechter say that "most people will not recognise the Third Wave when it starts"?
Could this be IT,(I sure don't feel confident enough to say it) or is everyone getting bullish and wiggling out of EWI?

[DG]

"A closer look at these estimates is vitally important in positioning your portfolio for the coming few quarters. In our 2010 investment outlook we said we were bearish about H2 2010 partly due to the potential for overly optimistic earnings analysis. If you look at current estimates analysts are calling for just 2.7% sequential growth in 2009 Q4 earnings. For 2010 Q1 they are calling for just 1.9% sequential growth. In a nutshell, they expect earnings to be in-line with the last few quarters (which I believe is utterly naive and lacking in any real analysis worthy of paid employment). These estimates are almost certainly low. Where things get interesting is in the later quarters of 2010.

In Q2 analysts are calling for a big jump in growth to 11.3% sequentially and 33% year over year. The same goes for Q3 where they are currently calling for 7% sequential growth and 25% year over year growth. These are big numbers. $19.72 & $20.62 in operating earnings per quarter is essentially what the S&P was doing back in 2006 & 2007 when the economy was at record low unemployment and the banks were cranking their high leveraged ponzi scheme on all cylinders. Can we realistically return to such levels so quickly? Call me a skeptic."

http://pragcap.com/are-earnings-estimates-too-high

[Greg]

Gondlier, if Prechter said it...it must be right!

[David]

count for the SPX seems to be playing out well. have updated it for those interested.

http://www.tradeyourwayout.com/2010/02/spx-wave-update-60-min-chart.html

[DG]

Didn't Prechter say that "most people will not recognise the Third Wave when it starts"?
Could this be IT,(I sure don't feel confident enough to say it) or is everyone getting bullish and wiggling out of EWI?

Posted by: The Gondolier | Tuesday, February 23, 2010 at 01:51 PM

I don't think this is a third wave of ANYTHING.

That said, it would make sense that at the end of the second wave of a large-scale formation, everyone would doubt that there would be a third wave. Once the third wave started, though, the number of "believers" would grow quite quickly.

[Mista B]

Which institutions, Dave B.? Goldman Sachs? Lehman? Merrill Lynch? Bear Stearns? Sorry, but that dog don't hunt! All one has to do is look at the stock market over the past two years. Does a 60% drop in the S&P followed by a 60% rise imply rationality? Or extreme irrationality? Also, when was this point in the past when the majority of stocks weren't held by a concentrated few? The people in institutions are still people, and the great majority have a long-only bias, not to mention very little knowledge of history.

The main part of my post, though, concerns the risk premium inherent in stocks at these prices when one factors in the economic landscape. This simply isn't like every other period of time over the past 100 years. Thus paying the historically average P/E is crazy, but it's not at all surprising that those pumping the public markets refuse to believe so. One look at private companies, CRE, or housing, on the other hand, shows no bounce of any kind. The risk premium is coming off. It'll take a while, though. At some point people will hate stocks again. We aren't there yet.

[Dave B.]

Mista,

In my opinion, you make a rather naive assumption that there is a high degree of correlation between equity prices . . . and the fundamental back-drop of the Economy.

I find that this is a most common mistake made by people who seek to "rationalize" why they have been short this market during such a substantial rise. It is also a common mistake made by people that are "new" to trading the equity markets.

Again, equity markets are driven by LIQUIDITY. It's amazing that so many people fail to see this.

[Dave B.]

"Which institutions, Dave B.? Goldman Sachs? Lehman? Merrill Lynch? Bear Stearns? Sorry, but that dog don't hunt!" --- Mista B.

I am puzzled as to why you would name a bunch of broker-dealers. They have nothing to do with anything except for facilitating/executing orders for their clients.

They are not "buy-side" institutions such as Janus, Fidelity, Vanguard, Barclay's, TRowe Price, etc.

[Roger D.]

The Wave 2 coil in AMZN

http://www.screencast.com/users/fast996/folders/Default/media/3394055f-6273-4166-8119-e8ced135a3c2

[Mista B]

Dave, my point was precisely that there often ISN'T a high degree of correlation between equity prices and the fundamental backdrop of the economy. There clearly hasn't been for over a decade--as demonstrated by the chart. When any asset becomes overpriced, its future growth potential diminishes. Equity investors in general have gotten zero return over the past decade, and it's likely what they have to look forward to over the coming decade. Fwiw, I had my clients in over 90% cash at the beginning of 4th quarter 2008 (thanks to the foresight of people like Yelnick, Dent, Mish, Denninger, Rithholz, and others). In the heart of the selloff I was buying like mad, especially high-quality dividend paying stocks that were trading at single digit P/E's and investment grade debt (not to mention some great high yields), for bonds were pricing in a much worse scenario. Locked in many 10%+ returns for years. I've been buying very little lately. Just don't see the value given the risks. Couldn't care less if the market keeps going up. Just getting more overpriced. From my perch as an advisor to businesses that service a basic business necessity, I'll see the turnaround with my own two eyes well before Wall Street will. Nothing of the sort is occurring on Main Street, so Wall Street is once again way off in its valuation. Doesn't mean the market is about to tank. I really don't think there's much money to be made going short at this point. Even if the market tanked 30%, how much could one reasonably expect to grab? I'd much rather be long, and my clients are. But they're long in stocks that pay double or more the dividend of the S&P and plenty of bonds in solvent companies. I've already warned them from this point forward not to expect much growth, but I've little doubt they'll do as well or better than the indices and with far less volatility. As for the private M&A deals I see, there's no doubt the risk premium has already been reduced. Follow the herd longs naturally don't want to hear that, but it's nonetheless true.

[Taz]

Here in OZ I believe todays weakness is a medium-term bearish tell. The sell-off today does not look sinister so I don't think we see any real fireworks to the downside yet. But wave c higher was only about 78% of wave a higher implying weakness. Essentially I think we may be down for a few days before we attempt a retest of the high next week. Then we see another shap move down.

[betterdays]

Institutions are the ones that DRIVE the equity markets, and NOT the average retail investor

Correectly said.. more than 80 % of daily stock trading is black box/ fast trades.. The average investor is just meat on a stick to professional traders

[Roger D.]

After all the hand ringing by the bears lately,one has to ask the Bulls; Is that all there is??? althogh many stocks have had deep retracements,it seems these two never left the station.

The GOOG and AMZN charts makes one wonder.

http://www.screencast.com/users/fast996/folders/Default/media/8b93e2f4-9193-42e5-a041-57354478c9d0

[Ant]

Taz

We have turned in the window of 7-12 days off feb bottom for a countertrend. I expect the low late next week at around 4200-4300 or no lower than 4030 and then that will be a screaming buy to the upside for the next few months into the longer term top.

[Taz]

Hi Ant

I am gunning for 4100ish sometime in March before a 2 month rally of 10% to 15% into June before we drop into 3700ish come September.

Re the very near-term i think there was too much momentum and volume for the market to turn down sharply here. I would prefer a retest, which I would coutn as wave c, on lower volume to signal the vulnerability of the market.
I think our banks are a dead giveaway that there is some more supide to come first.

Obviously I reserve the right to change my opionion ona dime.

[Webber]

Upstart get ready for starting down. In early 07 market bounced off rising trendline. We are now up against the declining trendline from Oct 07 for the 2nd time and broke the Hope Rally support line back in Oct. Take a look at Nov/early Dec 07 for a quite similar fractal of where we are now. Last week was the lightest volume except for a holiday week in 2 years, and the best advance in 3 months to end the rally. Volume has been on the downside and will pick up as sentiment slowly shifts. High stock values are not likely to be supported by currently optimistic earnings estimates as the curtain is pulled back to reveal the weak state of debt, GDP, employment and consequently, spending. The bubbles are still infated in almost every asset class due to liquidity! Why? Repeal of Glass-Steagal, mark-to-market accounting allow continued risk trading. Sale of worthless MBS to the Fed for new investment cash, or even turning it back for Treasurys on a very steep curve. Every attempt by the Fed so far is only delaying the inevitable, considering the multiplier effect of QE is less than one. Only the big banks have been saved, and the next time they're on the brink (which should be soon enough) will we save them again? FDIC bail-out fund in the negative, and that's not counting the full-price guarantee the sharks are getting for greatly discounted loans. Sovereign, CRE, private equity and consumer debt are all in critical phases prior to huge numbers of bankruptcies to come. Balance sheets will be obliterated and earnings slashed as the next crisis enfolds. Real estate inventory for sale will double or triple as the time comes to clear the debt. Deflation is here, just ask Uncle Ben (he is not sleeping well). You can lead a horse to water but you can't make him drink.

[Ant]

Taz

Would love a restest of high - please order for tomorrow!

[Taz]

My short-term model which is usually good for pinpointing the short-term direction of the ASX 200 and also indicating whether ASX 200 is a BUY or SELL has essentially retraced all of its early losses today while the asx200 remains down 1.4%. This bodes well next few days. That said it has underperformed quite badly over the past 5 days or so and particualry so over the past 30 days or so so the big risk is to the downside.

[Wave Rust]

buy before the march 2nd close. this is still only the first wave up. spx 1400 is very possible by summer's end.

congrats to tony caldaro. he's on to it now. read his post for today. '74 low and '82 low ,,, started the same way. slow and easy but relentless. i remember. I'll bet carl futia does too. LOL

this pull back is in a first wave up, that is, a 1st wave of a new bull market - short term and long term. the killer of traders in every new bull is the 2nd wave. its violent and deep and fast and seems to have no end (gates of hell aroma). this one could retrace 78% off the summer high,,, maybe even 88%. verticality breeds inverted verticality

wave 2 should start this summer from much higher. (go look at that chart I posted a few days ago)

For chris- whoever you are. - i suppose you aren't one of the authors of any of the original works that you are posting links to.

that long wave article is well known to have a major flaw, a glaring omission in the longwave esoterica. I'll leave it for you to find the glaring gaffe.

bull market? nearly 500 snp points off the lows, nearly 4,000 dow points off the lows, interest rates near zero.

are you waiting for new all time highs? I guess then you could call the up move an irregular B wave, right?

C'mon man!

from 1998 through today - the largest expanding formation ever - the upper bound is beyond view for the dow. it may take the compq and ndx 25 years from their 2000 high to get to new all time highs, but not the Dow.

Elliott wave is not inherently bullish because RN Elliott designed it that way. EW is bullish because people are naturally optimistic, despite what they may say in some survey. It's always a 5-3 ballgame. {the commies of russia, china, cuba etc. had a tactic that matches that "5-3" relationship - it was 2 steps forward, one step back, two steps forward, one step back. (Same tactic obama is using on EVERYTHING.)}

Their capital has to go somewhere. Most of the time it is in some type of security, bonds/stocks, taking on risk. Risk is taken because there is optimism of long and/or short term gain.

imho, the biggest mistake all "studious" ewavers make is being too bullish or too bearish too much of the time. I know from personal experience as well.

paradoxically, if you live long enough, the market is always more bullish when there is tons really bad news like huge unemployment, everything sucks everywhere, the end of the world is nigh, deficits are are taking candy from all the babies, etc.

cheer up, it's never that bad.

when it is really bad, you will know it ,,, because Walmart will be closed. permanently!

wave rust

[Chris]

Wave Rust -

First, to answer your question...

"are you waiting for new all time highs?"

No.

If you were to read carefully what I wrote I explained that it is perspective and I followed it with a fair example. Perhaps I was not clear, so I'll try to explain it one more time. If one was to observe the MAR '09 bottom and compare it to the current closing prices of the indices today, then yes, I would agree it is a bull market. But if you look at a long-term (20 + years) trendline then I would say we are in a bear market. Some use the 20 % marker to judge if its a bull or bear market. The high for the DJIA was 14198, multiply by 20 % = 2840, and the bull/bear line would be 11358. Today's closing price of the DJIA was 10282, 28 % below the high in 2007. Looking at the 50 and 200 daily/weekly/monthly moving averages and comparing it to today's closing price would result in a mixed picture. Unless you're talking time frame, calling it a bear or bull market is just noise/distraction.

I would call a new bull market based off of historical examples like single digit P/E's, gold matching or getting near a one to one ratio with the DJIA, and for the general public to lose the desire to own stocks.

[DG]

paradoxically, if you live long enough, the market is always more bullish when there is tons really bad news like huge unemployment, everything sucks everywhere, the end of the world is nigh, deficits are are taking candy from all the babies, etc.

Yes, I remember all the terrible news that bombarded us daily during the 1990's bull market. It was a non-stop deluge of awful stories about full employment, stock options making kids barely out of college multi-millionaires, technology creating new products and services no one could have dreamed of even a decade before and other horrors. Man, I'm so glad I don't have to live through that again.

[Chris]

Wave Rust -

You wrote:

"For chris- whoever you are. - i suppose you aren't one of the authors of any of the original works that you are posting links to.

that long wave article is well known to have a major flaw..."

No, I'm not the author to:

12,000 YEARS OF ELLIOTT WAVES
AND
WHAT THIS MEANS FOR THE 21ST CENTURY

But I do find it interesting, worth sharing and discussing. You say it is well known to have a major flaw, do you have a link to a critique of this piece? If so, I would like to read it. Thank you.

Oh, I forgot to ask, what is up with " C'mon man!"? I could guess, but my guess would not be PG - rated. Regardless, it comes across as rude and unnecessary. Good luck with that!

[Roger D.]

"You can lead a horse to water but you can't make him drink. "

"ABC Consumer Comfort Index Drops To -50, New 2010 Low And Just Four Point Above All Time Record Low"

The ABC News Consumer Comfort Index hit the dreaded -50 mark for the first time in nearly four months this week, a mere four points from its record low in 24 years of weekly polls. While the change isn’t statistically significant from recent levels, -50 is a psychological barrier – and not a happy one – for the index. This marks just the 25th time in 1,260 weekly polls the CCI has been this low. Remarkably, 23 of them have occurred in the past 16 months. Figure on a scale of 100 to -100, the index has averaged -48 so far this year, matching its 2009 average, its worst full year on record. Compare those to its long-term average, -13, much less its best year, +29 in 2000, and its best week, +38 in January that year. Those days seem far away.

The federal government has reported seasonally adjusted increases in initial jobless claims (up 31,000 to 473,000 last week) and wholesale prices (up 1.4 percent in January). Neither helps.

Another consumer confidence measure, by the Conference Board, startled Wall Street with a drop today, but it’s done monthly rather than weekly. The ABC CCI hit a short-term peaklet, -41, the first week of January, then sharply surrendered ground.

http://www.zerohedge.com/article/abc-consumer-comfort-index-drops-50-new-2010-low-and-just-four-point-above-all-time-record-l

This has to be the most expensive "dead cat bounce" in the history of humankind, of course that's what you would expect of a grand supercycle "B" wave.

Can you say scroomed.

Roger

[trendlines]

Yelnick & folks, here's a short-term bullish possibility for the hang seng index:

http://trendlines618.blogspot.com/2010/02/hang-seng-index-short-term-bullish-cup.html

[Taz]

A perusual of the materials index is sufficient to rule out any possibility of an impulse wave for the broader markets.

[Taz]

I should qualify the above statement by saying Aussie Materials.

I have never seen so much overlapping in my life.

The rally from Nov 2008 is more than 2.5 times the time of the May 08 to Nov 08 decline. It has retraced a little more than 61.8% on linear scale in that time.

Impulse waves are a dipiction of strong conviction about a market. They should cover more ground in less time than the prceeding corrective decline.

This is clearly not the case here.

Taz

[trendlines]

My outlook for SPX for the next couple of days:

http://trendlines618.blogspot.com/2010/02/s-short-term-drop-ahead-update.html

Expecting more downside to 1080-85 area, before any reversal. Good luck.

[e_djur]

"....bottom at around S&P400". Seems possible.
My strange but also possible idea:
1. gentle punishment is just S&P400, but
2. also possible but most painful punishment is S&P250
Crazy? But still within rouls. There must the time to conclude reasonably that mad printing money.

[Bird]

10:02 a.m.ny time: Despite this quick drowp, Dow 5 min high in 9:55 bar not tied out. Must go to new highs.

[Mamma Boom Boom]

>Again, equity markets are driven by LIQUIDITY. It's amazing that so many people fail to see this.
Posted by: Dave B. | Tuesday, February 23, 2010 at 02:43 PM<

There's a lot of truth in that. Just not enough to make it valuable.

[Dave B.]

"There's a lot of truth in that. Just not enough to make it valuable." - - - Mamma

And you have no idea how utterly WRONG you are about that. I suggest you might want to look at the weekly Federal Reserve Data like most professionals do.

[Bird]

10:43. New high achieved in Dow 5 min. The current high of the 10:40 bar does tie out. Doesn't guarantee that it is the final short-term high, but it satisfies rule for new swing to follow.

[DG]

"And you have no idea how utterly WRONG you are about that. I suggest you might want to look at the weekly Federal Reserve Data like most professionals do."

Have a link to a track record for this analysis? Otherwise, it's just your opinion.

I do want to thank you for slumming with us non-professionals, though. Is this part of some community service obligation on your part? I feel so honored to be in your presence.

[bob m]

Three attempts over 1100 in gold. If it falls here, it could fall for a while - stocks too.

[Mamma Boom Boom]

DG, he's probably another one of those who were 'Tudored', if you get my drift.

The S&P sure looks like it wants to close those 2 gaps, maybe 1110 yet today?

[Dave B.]

"I do want to thank you for slumming with us non-professionals, though. Is this part of some community service obligation on your part? I feel so honored to be in your presence." - DG

It's been pretty clear to the majority of the people here that you are a "Perma-Bear" that spends more time on blogs posting your bearish opinions and rationalizations as to why you "missed" one of the biggest moves in the equity market in decades . . . as opposed to actually having "skin" in the game on a daily/weekly basis.

Didn't you tell everyone weeks ago here that you were "done" showing up and posting on Planet Yelnick and that you were going to stick to you blog? What happened with that plan? Did your good buddy Glenn Neely kick in an extra "Happy Meal" so that you can continue shilling for him?

[Simpleton]

My kids love those happy meals.

[DG]

"DG, he's probably another one of those who were 'Tudored', if you get my drift."

Yes. I find it hilarious, yet somewhat disturbing, that someone would post here under multiple identities in order to make it seem like a group of people agreed with him. Either that, or Yelnick just got lucky and four schmucks with superiority complexes and a penchant for CAPITALIZING words in their posts showed up together.

[DG]

"It's been pretty clear to the majority of the people here"

If by "majority" you mean the multiple user-names you use to post, I guess I can't disagree with you there.

[TC]

Any guy that bashes Carl Futia must have a screw loose. That's when I lost respect for DG.

[Roger D.]

The infamous 28 days are coming up. This pattern in the Dow,ES futures,and SPX cash will produce the greatest financial panic in stock market history.

Roger

http://www.screencast.com/users/fast996/folders/Default/media/bc77ae8d-b045-4c34-b47d-66c0052fda56

[DG]

"Any guy that bashes Carl Futia must have a screw loose. That's when I lost respect for DG."

Right on cue, here comes the other sockpuppet.

I didn't "bash" Carl, I asked him a relatively simple question about the mechanics of his returns and I pointed others to a long-term 3rd-party review of his trading recommendations. Unless he's some kind of defenseless little girl, I don't see that as bashing, but as the kind of trading-related issues two normal adult men can discuss.

[Simpleton]

Roger, how do you know that this is true?

[DG]

"10:43. New high achieved in Dow 5 min. The current high of the 10:40 bar does tie out. Doesn't guarantee that it is the final short-term high, but it satisfies rule for new swing to follow."

I'm not quite getting another sell signal, but it was clear there was a divergence between the IWM/QQQQ and the SPY on that last push up, with the SPY making a slightly later high than either of the other two.

[Ray]

Roger, could you please expand on the "Infamous 28 days?" I must have missed this post. Thanks, Ray