1) Bullseye
Highlights
Panic P/Es
T
he markets are in the process of liquidation with lower lows interceded by strong rallies. Listening to the market takes
constant effort, and sometimes we can learn from the distant past. Since July 1997 (Asian Crisis), default risk has been
more of a concern to markets than inflation risk. Our awareness of prior Panics caused a swell of extreme discomfort in our
target prices for a market low. The
1600
market’s response to previous financial
S&P 500 Index
1550
panics (1929, 1937, 1973 and 1981)
The Confluence of Technicals &
Fundamentals
1500
can be very telling. Now, like then, we
1450
believe it’s crucial to study charts and
1400
fundamentals. We analyzed past periods
1350
of extreme volatility and a protracted
1300
credit stress and found P/Es near 12 are
1250
1200
the median for the S&P 500. Technical
1150
analysis is supported by fundamentals,
1100
with prices near 800 indicative of historic
1050
panic lows and in fulfillment of a Double
1000
Top (2000, 2007) & Bottom (2002,
950
2008/9?) price pattern. Many investors
Credit Stress may push S&P P/Es
900
to 12, which implies at best $67 in
who learned from previous markets may
2009 earnings, taking the S&P
850
view the market moving from 2007 Q3
down to technical support near 800
800
peak earnings (S&P 1576/$85.11 = P/E
750
18.5) to a more sustainable P/E like at the
700
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
October 10 low, where the market was
pricing in 2009 earnings near $70 (S&P
For the charts above and below, the data and performance displayed represents past
performance, which is no guarantee of future results.
839/ P/E 12).
A Historical Perspective
Valuation Points
Low P/E
Median P/E
By studying history, perhaps we can learn how the market adjusts
stock prices during times of crisis. Stock prices are decreasing to Panic
P/E levels. Since 1873, there have been eight Panics prior to the 2008
Panic. During each Panic Period, trough P/Es ranged from 7 to 17 with
medians ranging from 8 to 22. Median P/Es for each period are higher
when there is CPI deflation and lowest with annualized inflation greater
than 4.3%. The median and average of the lowest P/Es found during
each period are both 11.
1873 - 1877
1893 - 1896
1901 - 1903
1906 - 1907
1929 - 1932
1937 - 1938
1973 - 1974
1981 - 1982
Median
Average
2007 - ?
11
17
13
9
11
10
7
8
11
11
12.5
14
22
14
13
19
14
12
8
14
14
20
2) During our current Panic, the median P/E reported
over the last 12 months is 20 while the Panic trough
on October 10, 2008 was 12.5 (based upon the
market’s 2009 estimate of aggregate S&P earnings
near $70). Over the next few months we would
not be surprised to see the median P/E decline to
or below 14 if the inflation rates creep higher than
4.3%. With the Cowles & Smith Composite Index
prior to 1957 and S&P 500 Index thereafter, we
reviewed 25 stock market declines. The median
and average duration of all declines was 20 months
while respective price troughs for these measures
were -33% and -37%. The median and average P/Es
for the duration of all declines were 14 and 15. Panic
declines lasted longer (with a median of 29 months)
and were more severe (-46%).
Low & Median P/Es During Panic Periods
25 Bear Markets
START
END
(Blue = "Panics" )
MONTHS
CHANGE
52
43
12
34
22
22
22
13
21
34
12
5
31
37
6
8
18
23
17
16
2
3
3
24
20
29
20
12
-47%
-32%
-32%
-46%
-49%
-27%
-24%
-40%
-47%
-86%
-54%
-26%
-43%
-30%
-28%
-22%
-36%
-46%
-20%
-24%
-33%
-20%
-21%
-49%
-33%
-46%
-37%
-43%
2/27/1873
6/30/1877
1/31/1893
8/31/1896
9/5/1899
9/24/1900
1/12/1901
11/9/1903
1/19/1906
11/15/1907
11/19/1909
9/25/1911
9/30/1912
7/30/1914
11/21/1916
12/19/1917
11/3/1919
8/24/1921
9/7/1929
7/8/1932
3/10/1937
3/31/1938
11/12/1938
4/8/1939
9/12/1939
4/28/1942
5/29/1946
6/13/1949
12/12/1961
6/26/1962
2/9/1966
10/7/1966
11/29/1968
5/26/1970
1/11/1973
12/6/1974
9/21/1976
3/6/1978
4/27/1981
8/12/1982
8/25/1987
10/19/1987
7/16/1990
10/11/1990
7/20/1998
10/8/1998
9/1/2000
10/9/2002
Total Median
"Panics" Median
Average
10/9/2007
10/10/2008
CPI
P/Es
-8.1%
-5.3%
1.3%
5.3%
8.4%
2.1%
2.0%
23.4%
-4.3%
-21.4%
-0.7%
-1.4%
14.2%
29.3%
0.7%
2.4%
9.0%
21.5%
13.4%
9.7%
0.6%
2.2%
0.4%
4.1%
2.2%
2.3%
4.5%
5.1%
14
22
14
14
13
13
14
7
10
19
14
15
9
9
18
16
16
12
9
8
20
15
28
34
14
14
15
17
Cumulative
Conclusion
To match medians and averages, the current Panic
may not end until June 2009 or April 2010. Absent
of an extreme downturn, we may be approaching
Panics of 1873, 1884, 1929 & 1937 (CPI Deflation); 1901, 1907, 1973 & 1981 (CPI Inflation).
a Double Bottom in a secular bear market that has
Performance displayed represents past performance, which is no guarantee of
existed since 2000. It is critical to long term
performance that investors avoid market stampedes. future results.
Irrational exuberance turns to flight, flight to panic and panic can lead to outright disaster. Investors need to stay calm
during Panic Periods and avoid getting swept up in group hysteria. Instead, they should make independent decisions that
lead to profits, like buying when the crowd sells. Remember, financial markets are always shifting between greed and fear.
Historically, a declining market has always come back, regardless of how shocking the events were that drove it down.
When returning to the equity markets, investors should look for consistent gains and avoid the “home run” mentality. The
investor’s miracle is a steady compounded return over time. During Panic Periods investors should consider employing a
buying strategy that falls within a price range. Don’t make huge bets, instead scale in a portion (i.e., 20%) of investment
capital today and allocate more if the market drives the price down again. Buying into the equity market at sensible
multiples benefits the investor when the market ultimately returns.
Projecting the markets with P/Es - The worksheet below was designed to help estimate downside risk for the S&P 500 from a
P/E perspective. Columns A, B, and C employ the following: the average earnings reported in the past 5 years (20 quarters), 12-month
trailing reported earnings and operating estimates for 2009. The final column was provided to normalize the earnings estimate. The
worksheet provides two P/E estimates and the corresponding changes in the S&P 500 from its high and low:
1) P/E of 12 which reflects panics or protracted recessions
2) P/E of 16 which reflects the mean since 1940
S&P Prices Based On P/Es:
S&P 500 Earnings Results
Reported Earnings
5-yr Mean
12-month
"A"
"B"
65.32
51.83
Estimated
2009 Earnings
"C"
77.61
Normalized
Earnings
A+B+C
64.92
S&P 500 Price based on a PE of 12 (Panic P/E)
% Change from 10/10/08 Low (839.8)
% Change from 10/11/07 High (1576.09)
784
-7%
-50%
622
-26%
-61%
931
11%
-41%
779
-7%
-51%
S&P 500 Price based on a PE of 16 (Historic Avg since 1940)
% Change from 10/10/08 Low (839.8)
% Change from 10/11/07 High (1576.09)
1045
24%
-34%
829
-1%
-47%
1242
48%
-21%
1039
24%
-34%
Data Sources: Morningstar; Cowels & Smith. S&P 500 Operating Earnings by Economic Sector: Bottom-Up Estimates as of 9/23/2008. The
information provided is intended to be general in nature and should not be construed as investment advice. This information is subject
to change at anytime, based on market and other conditions and should not be construed as a recommendation of any specific security.
P/E Ratio: The price-to-earnings ratio is the price of a stock divided by the earnings per share. Standard Deviation: A statistical measure of
the historical volatility or risk of an investment. The higher the standard deviation, the greater the historical volatility of returns for investors.
0768-NLD-6/17/2009