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Stock Market P/E Ratios could fall to 5 Before the Market Hits Bottom

Stock-Markets / Stocks Bear Market Mar 17, 2009 - 12:59 PM GMT

By: FleetStreetInvest

Stock-Markets Best Financial Markets Analysis ArticleMeasured in terms of the price to earnings ratio (P/E), the US stock market looks good value. That's if you look at recent history and how the market was priced in previous recessions.

At the market bottom in 2001, for example, the P/E ratio of the US S&P 500 index was around 20. In the 1990-1991 recession, that figure was around 15.

So the current P/E of around 12 is not, historically, expensive at all. Maybe that's why investors are piling back into shares. Last week the S&P rallied 12.5% from the low of the week to Friday's close.

But if you look further back in time, you'll see that there's scope for shares to get a lot cheaper from here. Take a look at today's chart. It was created by respected Yale economist, Robert Shiller – the man who famously called the top of the 2000 bubble market in his bestselling book, Irrational Exuberance.

S&P 500 P/E ratio at previous market bottoms

The chart measures the P/E ratio by taking 10–year averages of earnings instead of year-by-year. That smoothes out the business cycle, making terrible earnings years like 2008 less important than the longer term.

Based on Shiller's calculations, the S&P 500 is currently on a ratio of 12. But as the chart shows, in major historic bottoms, prices have dropped to 5-8 times earnings.

Given the state of the economy, earnings are not likely to improve in the near future. So if things play out according to history, and the P/E ratio returns to the 5-8 level, then the market could have some way to fall.

The Daily Reckoning – This is not 2003

Paris, France

Tuesday, 17 March 2009

Pity the rich. Pity the CEOs. Pity the capitalists.

Poor Warren. He's down to his last $25 billion. And Bill Gates can barely hold his head up; his pile has shrunk to barely $18 billion.

And do a google search of “AIG outrage” and you will get 621,000 hits.

Alas, being rich isn't as easy or as much fun as it used to be.

The rally paused yesterday. The Dow lost 7 points. It could be over. More likely, it will run for a few months. Gradually, people will come to think that this is the real thing. They'll begin to imagine that it is 2003 all over again. Of course, it's not... this market has nothing in common with the Great Rebound of 2003-2007. (More below...)

Oil traded at $47 yesterday; it is slipping toward the $50 level. And the dollar is slipping around too – it is losing ground against the euro, now trading at $1.29/$. But it is mostly steady against gold, which seems to like the $900 - $950 range.

AIG is today's main story. Everyone is appalled, outraged... or apoplectic about it. First, we under-reported the amount in bonuses paid out. The real amount is $450 million, says the Wall Street Journal... and one member of Congress charges that many bonuses were disguised as other things... and that the real total is more like $1 billion.

The average lumpenvoter has no idea how bailouts work. He was willing to believe that giving Wall Street hundreds of billions in taxpayer money would somehow make his house go up in price, but now that he sees how it really operates, he is ticked off about it. He may not understand macro economics, but he knows chicanery when he sees it.

Under pressure, AIG revealed what it did with the bailout money. It came as no shock to us to discover Goldman Sachs at the top of the list of recipients. Goldman's main man was in the room with the feds – the only representative of Wall Street – when the decision was made to rescue AIG. What's more, the feds' main man at the time – Hank Paulson – also used to be the top honcho at Goldman. So the fix was in. The government gave money to AIG and AIG gave it to a long list of speculators – including Goldman.

This seems perfectly natural to us. If we'd been in on the fix we would have steered some of the loot our way. But the politicians are feigning shock and horror. Senator Grassley even said AIG management should “resign or commit suicide.” He later calmed down and said he didn't mean it.

But we would have simply edited his remarks, giving the schmucks at AIG a last chance to exit with honor: “Resign AND commit suicide, in that order.”

Barney Frank added that “maybe it's time to fire some people.” Why not? The feds own 80% of the insurance giant now. Go ahead; fire all the people you want. That's about the only pleasure a real capitalist has left to him. Reach out.... and fire someone today!

Elsewhere in the news, the economy continues to deteriorate. Industrial production fell 1.4% in February. And credit card defaults are at a 20-year high.

What next?

Which stocks can “beat the recession”?

Read on…

To read the Daily Reckoning in full, click here.


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