Too many people are impressed by the recent surge in stock prices.
Believe it or not, journalists are people, too! And it’s well-known that most of us aren’t exactly mathematicians (consider that a CYA disclosure in case I got a calculation wrong below). So I thought this might be a somewhat useful exercise on the recent surge in stocks.
Forget about whether it’s a dead-cat bounce or not (I say meoww!), the numbers, at least the percentages, are deceiving. Let’s do a little math:
Stocks (S&P 500) are up 35 percent from their bottom on March 9. Seems like a lot, huh? After all, at their nadir stocks were down about 57 percent from their October 2007 peak. At first glance, you’d think that means your index funds are only 22 points down, right?* Check those 401k statements. They’re still off a whopping 42 percent.
How so? the current 35 percent runup was off a much lower base (676.53) than the 57 percent crash (1565.15). Most people aren’t good at math. The financial press needs to give us a little help, putting the current mini-bull run in the context of the overall bear market.
A useful number for said context would be 131 percent. That’s how much of a bounce off the bottom it would take to get back to the October 2007 peak. Or 71 percent. That’s how much of an increase from today it would take to get back to par. Makes that impressive 35 percent look a bit different, no?
Even after the recent runup in stock prices, the markets are still well below where they were in the same time after the Crash of 1929. That’s how shockingly bad the fall from peak to trough was.
Let’s not lose sight of that.
* As “End the Echo” says below, good thing I put that CYA caveat in. I neglected to recalculate all my numbers after going back through the piece.
Of course, the historic P/E10 has never flat-lined on the average. On the contrary, over the long haul it swings dramatically between the over- and under-valued ranges. If we look at the major peaks and troughs in the P/E10, we see that the high during the Tech Bubble was the all-time high of 44 in December 1999. The 1929 high of 32 comes in at a distant second. The secular bottoms in 1921, 1932, 1942 and 1982 saw P/E10 ratios in the single digits.
Where does the current valuation put us?
For a more precise view of how today's P/E10 relates to the past, our chart includes horizontal bands to divide the monthly valuations into quintiles — five groups, each with 20% of the total. Ratios in the top 20% suggest a highly overvalued market, the bottom 20% a highly undervalued market. What can we learn from this analysis? Over the past several months, the decline from the all-time P/E10 high has dramatically accelerated toward value territory, with the ratio dropping from the 1st to the upper 4th quintile in March.
A more cautionary observation is that every time the P/E10 has fallen from the first to the forth quintile, it has ultimately declined to the fifth quintile and bottomed in single digits. Based on the latest 10-year earnings average, to reach a P/E10 in the high single digits would require an S&P 500 price decline below 600. Of course, a happier alternative would be for corporate earnings to make a strong and prolonged surge. When might we see the P/E10 bottom? These secular declines have ranged in length from over 19 years to as few as three. The current decline is now in its ninth year.
#1 Posted by Scott Stoney MBA, CJR on Thu 18 Jun 2009 at 02:00 AM
Glad you CYA in the beginning, although I think this is rounding errors.
You wrote up 35% after being down 56% percent would mean you were only down 19%, but 56-35 = 21, not 19. Addition and subtraction are usually easier than percentages.
Otherwise your point about explaining the math of percentages is dead on. You talk about the context, the need for 131% from the bottom, or 71% from current Dow to get back to the peak, using the raw numbers, not solely the percentages would be an easy way to provide that context without confusing folks that don't get percentages.
Similarly, is the Dow the best measure for economic health (I dare you to ask Dean Baker at CEPR)? It is the most famous gauge, but it covers, what 30 blue chip companies. S&P might be a better over all gauge.
#2 Posted by End The Echo, CJR on Thu 18 Jun 2009 at 12:10 PM
good catch End the Echo--thanks!
I had gone back and switched one of the inputs and forgot to change the output. Good thing indeed, I put in the CYA, but no excuse.
And I agree that the Dow is definitely not the best gauge. The S&P (which is what I used) is far more representative of the overall market.
#3 Posted by Ryan Chittum, CJR on Thu 18 Jun 2009 at 02:28 PM