Americans are an impatient lot. 2008 was a wretched year for most of us, as virtually every asset class was brutalized in a synchronous, global recession. Furthermore, this has not been your “garden variety” recession but rather one induced by severe imbalances in the world’s financial system that will take years to work through. Now, as we blessedly enter a new year, many people are pining for some good economic news. For stock investors, this would entail the end of what has been an almost decade-long bear market.
The forecasts for the coming year for the U.S. stock market are as varied as one can imagine. Bearish analysts point out that corporate earnings estimates are still too high for U.S. equities and, after entering more realistic earnings numbers for the broader indices, the market’s price-to-earnings multiple is far from cheap. In his weekly newsletter for this week, John Mauldin points out the valuation problem confronting U.S. equities. S&P 500 earnings estimates for 2009 are currently $42.26, which is down from $92 in March of 2007! That gives us a market multiple in the low twenties—above the historic average of 15 and not the kind of territory one expects to see at the end of a secular bear market.
Other analysts point out that the market is a forward-looking, discounting mechanism and that using trough earnings (those at the very nadir of a recession) when computing valuation measures is not a good idea. Many analysts would prefer to use normalized earnings which factor in all phases of the business cycle. John Hussman prefers to use peak earnings, which uses the overall market’s prior peak earnings number as the divisor. The theory behind using peak earnings is that the broader market’s earnings power always returns to previous levels after recessions abate and this number is a more reliable measure of market valuation than using a divisor which may be heavily skewed in one direction or the other. By Hussman’s measure, the market is currently pretty inexpensive.
Other factors must be considered as well. One is the overall state of valuation of competing asset classes. Looking back at the end of the last major secular bear market in 1982, riskless investments such as short-term CDs, savings accounts, etc. were yielding close to 20%. Comparable investments today offer yields which are heading for zero! Real estate has certainly lost its allure and is still over-valued in many parts of the country compared to equities.
Foreign equities—also beaten down badly in the ongoing bear market—probably have diminished allure at present as investors flock to safer havens. Commodities offer a less appealing alternative as well, given the dismal performance so many of them turned in last year. While radio and cable television ads touting gold are ubiquitous, gold’s price is far from cheap.
