In our 2009 Panic P/E piece we talked about how the markets were 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. Our
awareness of prior Panics caused a swell of extreme discomfort in our target
prices for a market low. |
On March 23, 2020, the markets were in the process of liquidation.
The S&P 500 was down nearly -34% from its all-time high on February 19,
2020. The steepest and fastest crash since its history and that includes the
Great Depression era. Just as then stocks hit lower price lows interceded by
S&P 500 Index & Equity Market Price Earning (P/E) and
Earning Yield (EY)
For the charts
above and below, the data and performance displayed represents past
performance, which is no guarantee of future results. Source Morningstar
June 30, 2020
|The market’s response to previous financial panics (1929, 1937, 1973 and 1981) can be very telling. Now, like then, we believe it’s crucial to study charts and fundamentals. We analyzed past periods of extreme volatility and a protracted credit stress and found P/Es near 12 are the median for the S&P 500. Technical analysis is supported by fundamentals, with prices near 800 indicative of historic panic lows and in fulfillment of a Double Top (2000, 2007) & Bottom (2002, 2009) price pattern. Many investors who learned from previous markets may view the market moving from 2007 Q3 peak earnings (S&P 1576/$85.11 = P/E 18.5) to a more sustainable P/E like at the March 6, 2009 low, where the market was pricing in 2009-2010 earnings near $55 (S&P 666/ P/E 12).|
A Historical Perspective|
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. The 2008 Panic, the median P/E reported over the last 12 months was 20 while the Panic trough on March 6, 2009 was 12.1 (based upon the market’s 2009-2010 estimate of aggregate S&P earnings near $55). During the five years following the 2008-2009 Global Financial Crisis (GFC) P/E remained between 15 – 20, then soared to 25 in 2016, then stayed between 20 – 24 until 2020. P/Es exploded to 27 near the S&P 500’s peak in February 2020. Federal Reserve Money Printing and corporate bond purchases diffused the Panic as P/E neared 21 and have since ballooned to 37 as the S&P 500 rallied about 40% from its March 23, 2020 low.
The table below, employs the Cowles & Smith Composite Index prior to 1957 and S&P 500 Index thereafter, With that data we identified 25 stock market declines. The median and average duration of all declines was 18 months while respective price troughs for these measures were -33% and -38%. The median and average P/Es for the duration of all declines were 14 and 16. Panic declines lasted longer (with a median of 29 months) and were more severe (-46%).
25 Bear Markets (Blue = “Panics”)|
Panics of 1873, 1884, 1929 & 1937 (CPI Deflation); 1901, 1907, 1973 & 1881 (CPI Inflation). Performance displayed
represents past performance, which is no guarantee of future results.
To match medians and averages, if a 2020 to 2021 period Bear Market were to occur; the S&P 500 would have to plunge -50% to -62% in a secular bear market that would be rationale and normal historically! It is critical to preserve long term performance, investors need to adjust their portfolios to withstand market risks and to have an investment plan to sustain them through market panics.
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, but only if they have time! During Panic Periods investors should consider employing a buying strategy that falls within a price range and to hold a balanced portfolio that includes defensive assets and/or strategies that potentially provide absolute returns irrespective of the stock market trends. Investors with capital to invest, 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 estimated for 2020. 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:
- P/E of 12 which reflects panics or protracted recessions
- P/E of 16 which reflects the mean since 1940
Performance displayed represents past performance, which is no guarantee of future results.
Morningstar; Cowels & Smith. S&P 500 Operating Earnings by Economic
Sector: Bottom-Up Estimates as of 6/30/2020. 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. Earning Yield a
percentage of how much a company earned 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
performance is not indicative of future returns. Historical information is
provided for comparative purposes only. Any forecasts or forward-looking
statements may or may not occur. This material is intended to be general in
nature for informational purposes only. This material is not to be considered
investment advice and is not a recommendation, offer or solicitation to buy or
sell any securities. Investment objectives, time horizons and risk tolerances
vary, and therefore, this material was not prepared for any individual. The
opinions expressed are those of the author(s) as of the time the material was
prepared and are subject to change with time as market conditions vary. The
information, graphs and data contained herein are derived from proprietary and
nonproprietary sources, and have not necessarily been audited for accuracy,
despite being believed to be fair and accurate. As such, no guarantee nor responsibility
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