Tuesday, August 18, 2009 0 comments

Financial Times' John Authers view of the current rally & my view of the situation

Financial Times' John Authers produced a video clip a week ago, illustrating the current situation compared to the past. You may have seen similar information from various sources but this video synthesizes the various views.

I rely more on P/E ratios and it's really hard to tell if the market has entered a bull market. I don't believe it has because the P/E ratio looks high. Although corporate earnings, at least in America, have soundly beat analyst estimates—my impression is that it is not common to see analyst estimates beat on such a mass scale—the future profit level looks weak. One has a make a macro call here since the forward-looking earnings will be unlike anything we have seen (this isn't a normal recovery from a recession.)

As Authers points out in the video, P/E ratios are influenced by interest rates and interest rates are really low. If interest rates remain low—I lean towards deflation so I think they will stay low—then the P/E ratio isn't so bad. But if you were in the high inflation camp and think interest rates would hit, say, 5% within 2 years, then the P/E can plummet easily.

One final point I want to make is that I don't look at the market quite like many, including John Authers. I view the market peak as being in 2000. In contrast, most commentary treats the major peak as being in 2007. This makes a huge difference!

If you pick 2007 as the multi-decade peak, the market has fallen quite a bit but nothing like the catastrophic losses in the 30's or the 70's.

However, if you pick 2000 as the peak, its performance in real terms during the last 10 years is on par with the 1929 to 1939 period. Here is a chart from a post earlier this year:

Now, you might wonder, 'if it has fallen as much as in the 30's, can it fall more?'. The answer, believe it or not, is a 'yes'. The reason is because valuations in the late 90's were far higher than in the late 20's. The credit bubble, which actually didn't peak until 2005 or thereabouts, is also much larger.

If you set the ultimate peak as having occurred in 2000, you will look at the world slightly differently. You would actually be a bit more bullish because there has already been a severe correction—and I'm not talking about the crash from 2007; I'm talking about the poor performance since 2000. Those who see 2007 as the peak will be more bearish because the correction from 2007-2009 is not that severe compared to the 30's.


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