I particularly liked Seven Reasons the US Today is Not Like Japan 15 Years Ago.
This is a brand new blog, brought to my attention by Menzie Chinn of Econbrowser.
I particularly liked Seven Reasons the US Today is Not Like Japan 15 Years Ago.
This is a brand new blog, brought to my attention by Menzie Chinn of Econbrowser.
Well Mr. Hymas, where do you think the bottom is? I knew the Congress was going to “screw it up” and not go for the bailout. Said as much on your site a few days back. Gives me no satisfaction as I was already losing my proverbial shirt in everything while the bill’s passage was in doubt. Now it’s very very bad.
Well Mr. Hymas, where do you think the bottom is?
No idea!
I don’t mean to sound flippant or callous, but I don’t do market timing.
If you own stock in good companies; you are well diversified by sector [to reduce macro-economic hazards]; and you are well diversified by issuer [to reduce problems if you were wrong about which companies were good]; then, over the long term, you’ll do fine.
I hope you’re right. Have quite a bit in Can bank preferreds. Even have some Fortis prefs (power line co. not the bank) On pins and needles as I have a GMAC Canada bond maturing Sept 30 (tomorrow) and hope and pray the Jewish holiday stands between me and their declaring bankruptcy. ResCap, their subsidiary, was counting on this bailout. Also have Investors Group bonds and, despite numerous emails, they simply refuse to tell me the extent of their exposure to Lehman, Wachovia, WaMu. AIG. Very disheartening to say the least! On a lighter note, this will result in buying opportunities. Credit is going to be hard to come by, interest rates will go up and although my preferreds may lose a little face value, future monies invested are going to yield significantly higher returns.
Where’s the bottom?
My own assessment is that S&P-500 reasonable valuation on a long term basis could be 900 ($45 EPS equating to 5.6% After-Tax Profit to GDP) times P/E = 16.
Of course, we all know that reasonable long term valuations are passed rapidly on the way down — so pick your number: 600 is feasible. I think the decline could come in lurches like today interspersed with hopeful rallies because most market participants are still in “buy the dips” mode that worked for the past 20 years but is not appropriate to (a) declining economic growth and (b) a severe and growing credit crisis. A few more days like this and nobody will have much money with which to buy those dips any more.
Creationist American conservatives (reflecting the noise of the people) have voted down the first attempt to try to save the financial system…. I guess they want their pound of flesh from what they perceive to be Wall Street Barons, but is actually their own pocket. But, like evolution vs creationism, logic or knowledge plays no role in their quest for revenge.
S&P supplies a spreadsheet of recent S&P Earnings and estimates – currently estimated at $77 for 2008 and $104 for 2009.
May I assume you mean that
Sorry, I was typing too fast: $55 in EPS equates to the after-tax profit to GDP of 5.6%. P/E of 16.2 (post war average) x $55 EPS = 891.
I am aware of S&P estimates. You link to bottom up estimates, which are way higher than top down estimates AND there are huge differences between as-reported and operating EPS (the 2009 forecast for as reported top down is $60). In any event, all these estimates have been falling steadily all year. I use the as-reported number, which, over long periods of time smoothes out “extraordinary” write offs that aren’t so extraordinary. The peak “as reported” number was about $85 around Jun 2007 and corresponds to an all-time high of 9.1% in After-Tax Profits to GDP (vs 6.0% post war average and 5.2% 1970-1995 average).
Thanks!
For those interested, I found a publication regarding this method of top-down fundamentals, which is consistent with the idea that profit varies around 5.6% of GDP.
What I don’t have is support for the idea that 5.6% of GDP implies $55 EPS on the S&P 500. Do you have a source for that, prefhound?
Your link is to a 2003 report saying stocks were vastly undervalued. In the short term this guy was right. I note, however, that his analysis is somewhat confused by using nominal profits and GDP rather than real profit and GDP.
However, in 2003 I started writing that the forward-looking long run returns from stocks were only going to be 6% (2% dividends + 2% long run real growth in EPS = 2% inflation) — so were overpriced compared with some fixed income alternatives. Historical backward-looking stock returns closer to 10% include much higher dividends (because P/E was lower) and about 1-2% from P/E expansion (depending on the period). Real S&P-500 EPS growth was around 2%. I started looking at this with Shiller’s Irrational Exuberance data base, which I have kept up to date.
For example, from 1950 to Aug 2008, the S&P-500 returned 11.4% made up of:
3.5% of dividends + 3.8% of CPI inflation + 2.1% of Real EPS growth + 1.9% of change in P/e (from 7 to 25 — using trailing as-reported EPS). The dividend yield in 1950 was 6.9% vs 2.3% now.
Very simplistically, if peak EPS was $85 with 9.1% after tax profit, then one can multiply 5.6% / 9.1% x $85 to get just under $55. It is actually a little higher than this to compensate for the nominal growth since the peak (inflation plus long run real EPS growth).
There are other routes giving similar conclusions: regress after-tax economic level profits on S&P-500 EPS and you get EPS = A*ATP**0.8 (where ** is a power to avoid crashing this window). There is no a priori reason why the power law should be 1.0 as tax laws, capital requirements and lots else has changed over the decades. This gives about $50 as a June 2008 S&P-500 EPS mid-point.
Another interesting angle is “in the 1980s financial profits were 10% of S&P-500 profits, but they rose to 40% recently”. If 30% of $85 in peak EPS was unsustainable financial profit (i.e. not real and being unwound today), we get about $60 as PEAK EPS today for 1980s-like S&P-500, so might expect something less again for “normal” economic conditions.
This sort of math gives me some comfort about the “normal” level of EPS (and perhaps the stock market, although P/E is a bit hard to forecast!).
What I have no clue about is whether the interlinked and highly leveraged banking system can take spiralling losses in asset values. You don’t need to recognize a lot of financial pain at 25X leverage before equity is wiped out! How much below “normal” economic conditions can this take us? The 1932 S&P-500 dividend yield at the low was 14% — and that was AFTER actual dividends had fallen 35% since 1929.
Sorry, typo 6% long run growth = 2% dividends (2003) + 2% real EPS + 2% inflation.
I had to do some research a few years back (about 2005 or 2006)regarding U.S. corporations after-tax profit margins. I found that the long term average profit margin for corporations overall is about 6%. But if you look at the largest corporations, their long term average profit margins are somewhat higher. For the S&P 500 corporations, for instance, i found that the long term average profit margin is about 6.5%.
The derivation of normal S&P-500 EPS from US GDP is probably getting less reliable over time as the indexed companies get more multinational.