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Bear Market Valuations, Conditions Saying Market Not Cheap


A closer look at current stock market valuations and support for why the market is overvalued here.

Listening to a half a dozen "Giants of Investing" at a conference recently, I could hardly hold back my scoff when one very notable money manager pointed out that according to the current comparatives of the P/E on the S&P 500 (INDEXSP:.INX), "It's cheap relative to everything, it's the only market that hasn't really risen to new heights." When asked about current valuation, he replied that "It is really, really interesting. I hate to say how cheap it is."

This is where I almost fell out of my seat. Out of what fantasy land could these fundamental experts and valuation-driven money managers come to this bonkers conclusion -- stocks are cheap!?

Granted, I will admit I am somewhat of a purist when it comes to technical analysis and don't peak my head over the fence into fundamentals all that often, but given this particular topic, I couldn't resist offering my two cents. My first notion is that there are probably many new and complex fundamental models that are invented every day, measuring every bit of accounting information available that I probably don't know about. Coupled with sustained negative real interest rates and the recent changes in 'mark to myth' accounting standards, this could have skewed fundamental valuations off into lala land in ways I might not fully understand. I still think the following focus charts are three very important fundamental bear market valuations and conditions that are reached when major bear markets end.

Condition 1: S&P 500 P/E at or below 10

At the bottom of all prior major bear markets (1922, 1933, 1950, and 1983) the P/E ratio dropped to a range of five to 10. Granted there were other minor bear markets that occurred in between where valuations did not become this cheap, but at the end of major debt cycles one would think they should. Like the one we are currently in, the natural deflationary forces flush out previous excess credit and malinvestments to the point where real values catch up with reality. At the crash low in 2009 the S&P 500 P/E reached 13 at its lowest point and rose to 23 in mid-2011. This is the first indication to me there is still far too much generational enthusiasm and insatiable thirst for speculation in stocks to even consider the notion that stocks are "cheap." It could even be argued that the lowest bear market valuation we saw in 2009 was a bounce of levels that were higher than many previous bull markets! I believe that the most likely scenario is when we do finally reach the bottom of this current major bear market cycle investors will be completely despondent, no one will have any interest whatsoever in the stock market, and working in finance will be considered a poor life decision by most parents. Stocks will then be on sale at extremely fire sale low P/E multiples at levels congruent to that of normal statically historic measurements of previous bear market bottoms.

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