Post of the Day
August 10, 1998
Dell Computer Folder
Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light.
Subject: Re: Near-term Bottom
History teaches us that bull markets do not last forever. Sooner or later, I believe sooner, the markets are going to correct or whatever you what to call it 15-25%. S & P has a current P/E of 28, historically very high.
A correction like that is an easy call. Of course it will happen. The Nasdaq just dropped 14%, in fact, at its low on Wednesday afternoon. S&P down 11%.
The bear argument that simply doesn't hold water is "Historical P/E is 15, therefore any value higher than that is overvalued." It's not that simple. Stocks are a competitive asset. The only thing a "historically average P/E" tells you is what the market has looked under "historically average conditions."
We are seldom living in "historically average conditions." Kinda like how a class can take a test and average an 85 even when nobody in the class got an 85.
The other problem is that "Historical average" tries to sum up whole classes of data which may not really even be relevant. Why does the market in 1910 have to have ANYTHING to do with the market today? I'm not saying it definitely doesn't but there's no reason it has to either.
If conditions change, you can't weight all the data in the sample evenly.
|"In the market, there are so many variables that interact in such a complex manner that I think the statement 'The market is overvalued' is a meaningless one."|
Take baseball for example. Look at the number of Home Runs hit per game played over the last 30 years. It's much higher than the "Historical average."
This can mean two things. Either we'll regress to the historical mean OR conditions during that sample have changed. For the baseball example, it's easy to say conditions have changed. Summing up data prior to 1920 and "averaging it" with data afterwards isn't very useful because before 1920, we lived in the "deadball era" when home runs were very difficult to hit because of the composition ofthe baseball (and many other reasons - I'm oversimplifying just for argument's sake).
In a sample like this, it is more likely that recent data should be weighted more heavily than less recent data. Again, if we want to predict how many home runs will be hit in baseball next year, we'll do better picking the most recent 10 years of data then we will in picking , say, data from 1914-1924.
In the market, there are so many variables that interact in such a complex manner that I think the statement 'The market is overvalued' is a meaningless one.
The argument that DOES make sense is "Conditions are so great now that they only have one way to go - down." That's the argument bears should be making, IMHO, not the "The market is overvalued now". 'Cause nobody knows what the "right" value is under current market conditions.
The Post of the Day may be edited for readability or length, but never for content. The opinions expressed in the Posts are those of their authors, and not necessarily The Motley Fool. We make no claim or warranty as to the veracity or accuracy of any post, and present this feature only as an example of what may be found on our message boards. Don't take the Post of the Day, or anything else here, as gospel and, as our seventh grade English teacher, Mrs. Peacock, used to say, do your own homework, and avoid run-on sentences.