High Price/Earnings Ratios and the Stock Market: a Personal Odyssey
After some in years of banking and investments, I retired as a matter of fact forty 2001. Interestingly, But since I do not golf, I soon found retirement to be very boring. So I decided to return to the investment world after ten months. Interestingly, However, those ten months were not a complete waste of time, for I had spent them in trying to utilize my forty years of investment experience to gain perspective on the most recent stock market “bubble” and subsequent “crash.”
There were several people who saw the stock niche crash coming, but they had different ideas as to when it would occur. Those who were too early had to suffer the derision of their peers. It was tough to take rules stand when so many were proclaiming that we were in a “novel era” of investing and that the former a no longer applied. Since the beginning of 1998 through the field high of March 2000, among 8,000 stock recommendations by Wall Street analysts, only 29 recommended
“sell.”
I am on record as having called for a cautious approach to investment two years before the “Crash of 2000.” In an in-house investment newsletter dated April 1998, I have a picture of the “Titanic” with the caption: “Does anyone see any icebergs?”
When I resumed employment in 2002, I happened to glance at the chart on the last page of Value Line, which showed the stock niche as having topped out, by coincidence, in April 1998, the same date as my “Titanic” newsletter! Interestingly, The Value Line Composite Index reached a high of 508.39 on April 21, 1998 and has been lower EVER SINCE! Interestingly, But on the first22page of the same issue, the date of the niche high was given as “5- -01”! When I contacted Value Line about this discrepancy I was surprised to explore that they had changed their method of computing the index , for “industry highs” from “geometric” to “arithmetic.” They said they would alter the name of the Value Line “Composite” Index to the Value Line “Geometric” Index, since that is how it has been computed over the years. Actually, Currently Value Line is showing a recent industry low on 10-9-, and the most recent niche high02based on this new “arithmetic” index, on 4-5-04, ANOTHER ALL-TIME HIGH! If they had stayed with the original “geometric” index, the all-time high would still be April 21, 1998!
Later that year, I was pleasantly surprised to scan in “Barron’s” an interview with Ned Davis, of Ned Davis Research, that said that his indicators had picked up on the bear market’s beginnings in April 1998, the same date as my “Titanic” newsletter! So!my instincts were correct, I believe that we are in a “secular” downturn that began in April 1998 “ theandBubble of 2000” was a industry rally in what was already a long-condition bear field.
Actually, Another development transpired soon after I resumed employment in 2002. I happened to notice one day that, in its “Industry Laboratory,” “Barron’s” had inexplicably changed the P/E Ratio of the S&P 500 to 28.57 from 40.03 the previous week! I and others wrote to “Barron’s Mailbag” to complain about this modify and to disagree with it, since these fresh P/E ratios could not be compared with historical P/Es. This was due to a change to “operating” earnings of $39.28 from “net” or “reported ” earnings of $28.31 the previous week. “Barron’s apparently accepted our arguments and, about two months later, changed go back to using “reported” earnings instead of “operating” earnings and revised the S&P 500 information to show a P/E Ratio of 45.09 compared to a previous week’s 29.64.
But a similar problem occurred the proceed day in a sister publication to “Barron’s.” On April 9, 2002, “The Wall Street Journal” came out with a novelthatformat included, for the first time, charts and in modern times facts for the Nasdaq Composite, S&P 500 Index and Russell 2000, in addition to its own three Dow Jones indices. I had given them examples showing where some financial writers had inadvertently confused “apples” with “oranges” by comparing their P/E of 19, based on “operating” earnings, with the long-term average P/E of 16, based on “reported” earnings. The P/E Ratio for the S&P 500 was given as 26, instead of the 45.09 right away found in “Barron’s.” I wrote to the WSJ and after much correspondence go back and forth, they finally accepted my argument and on July 29, 2002 changed the P/E Ratio for the S&P 500 from 19 to 30!
Because I started to be cautious about investing as early as April 1998, since I thought that price/earnings ratios for the stock niche were perilously high, I was not hurt personally by the “Crash of 2000” and had tried to get my clients into less aggressive and more liquid positions in their investment portfolios. But the pressures to go along with the industry were tremendous!
Indeed, Price/earnings ratios do not enable us to “time the niche.” But comparing them to past historical effectiveness does enable us to tell when a stock niche is high and vulnerable to eventual correction, even though others around us may have lost their bearings. High P/Es alert us to a need for caution and a conservative approach in our investment decisions, such as a renewed emphasis on dividends. In fact, Very high P/Es usually indicate a long-agreement bear field may ensue for a very long period of time. Actually, We are apparently in a long-term bear nichesuchimmediately. In fact, But in determining whether the niche is high, we must be vigilant with regard to what data mambers of the financial press are reporting to us, so we can compare “apples” with “apples.” When the financial information does not appear to be correct, we, as financial analysts, owe it to the investment community to challenge such information. It’s worth noting that That is what I have concluded from my personal “odyssey” in the investment world.
After three years of the DJIA and the S&P 500 closing below their previous year-end figures, the market finally closed higher at the end of 2003. But the P/E ratio is still high for both indices.
Does anyone see any icebergs?
