January 3, 2011
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Robert Shiller was on CNBC New Year’s Eve to make his forecast for the S&P 500 index in 2020. His best guess is a 1430 level which works out to 14% price appreciation over the next ten years or 1.3% annually. Taking no issue with the P/E multiple he uses but only analyzing the earning forecast I believe he may be slightly optimistic. He arrives at the 1430 level as follows:
- Real earnings in 2020 are 78.20 per share. He is assuming real earnings growth of 1.5% per year which is the long-term average.
- CAPE (cyclically adjusted price earnings) or PE10 ratio of 15. This is the 1890-1990 average P/E. He excludes the “bubble” years of 1990-2010 which would inflate the average P/E to 16.
- Annual inflation of 2%
- Result is a 1430 level on the S&P.
This is hardly an overwhelmingly optimistic forecast but Read more of this post
November 21, 2010
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Last week, in his weekly market comment, John Hussman posted an interesting chart (see below) comparing the corporate profit to GDP ratio and the subsequent growth rate in corporate profits. I have previously posted on profit margins (see here and here) and will now further explore what profits margins at current levels imply about the next five years for the S&P 500 index.
But first a question: why is the current level of corporate profit margins so important?
When looking at the market through a P/E (Price divided by earnings) framework it becomes obvious that any price appreciation, by definition, must come from an expansion in the P/E multiple, an increase in earnings or both. Experts disagree on what, exactly cause an expansion or contraction in the P/E multiple but the general consensus is that it is due to the level of inflation, interest rates, investor sentiment or a combination of the three. Read more of this post
February 19, 2010
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Discussion in the financial blogosphere is persistently taking place over where the market is headed. Recently I read someone pondering if we were at a level similar to 1992; a little more than a year into what would end up being a 10 year bull market that saw the S&P 500 run from the 320 level to the 1520 level in May of 2000.
Strictly looking at price of today’s market vs 1992 they are similar. Using Shiller’s P/E 10 the S&P is priced at 19.6 today vs 19.8 Jan 1992.
The difference lies in the earnings. In 1992 real earnings were below the long-term trend of an approximate 2% real growth rate in earnings. From 1992 to the market peak in the spring of 2000 real earnings grew at an annual rate of 11.24%. That is nearly 8 years of real earnings growth at 11+%. From 1995 through the midpoint of 2008 earnings were well above trend save for the recession of 2002. It appears with the massive reduction in earnings in 2008 and 2009 and the subsequent recovery we are now back in line with the long-term trend.
Simple statistics tells us that we are less likely to experience above average growth when starting at the trend then when starting below trend. Think mean reversion.
Unless we are willing to assume a continuation of the debt driven, record profit levels of last decade a reenactment of the bull market started in 1992 does not appear likely.