Monday, October 13, 2008

Columbus Day

With the holiday, markets are trading very light as banks and bonds are closed today. Please do not read too much into todays action as volume is light, participants are few and quite frankly this bounce is way, way, way overdue. That said stops are to be honored, light volume or not.

I came across the following article by Richard Shaw which discusses P/E and whether or not this market is cheap. The article uses some work by Jason Zweig 10 yr weighted average earnings which seem more reasonable. That said, the reading is not for faint of heart. From Mr. Zweig's article comes this;

Robert Shiller, professor of finance at Yale University and chief economist for MacroMarkets LLC, tracks what he calls the "Graham P/E," a measure of market valuation he adapted from an observation Graham made many years ago. The Graham P/E divides the price of major U.S. stocks by their net earnings averaged over the past 10 years, adjusted for inflation. After this week's bloodbath, the Standard & Poor's 500-stock index is priced at 15 times earnings by the Graham-Shiller measure. That is a 25% decline since Sept. 30 alone.

The Graham P/E has not been this low since January 1989; the long-term average in Prof. Shiller's database, which goes back to 1881, is 16.3 times earnings.

But when the stock market moves away from historical norms, it tends to overshoot. The modern low on the Graham P/E was 6.6 in July and August of 1982, and it has sunk below 10 for several long stretches since World War II -- most recently, from 1977 through 1984. It would take a bottom of about 600 on the S&P 500 to take the current Graham P/E down to 10. That's roughly a 30% drop from last week's levels; an equivalent drop would take the Dow below 6000.

Could the market really overshoot that far on the downside? "That's a serious possibility, because it's done it before," says Prof. Shiller. "It strikes me that it might go down a lot more" from current levels.

In order to trade at a Graham P/E as bad as the 1982 low, the S&P 500 would have to fall to roughly 400, more than a 50% slide from where it is today. A similar drop in the Dow would hit bottom somewhere around 4000.

As I have said previously, the pendulum can and does often swing to extremes in both directions. Something to keep in mind when the the shills on TV tell you the market is cheap.

Housekeeping notes;

On Friday I was stopped out of my long KGC position at $12.95 for a loss of 2.5 pts on 1 unit.

I was also stopped out of my long GG position at $24.40 for a loss of just over 5 pts on 1 unit.

This morning I was stopped out of my short AAPL position as the stock gapped up on the opening at $104.75 for a gain of just over $73 pts on 1 unit.

Good speculating to you all and never forget that "an investor is a speculator who made a mistake and will not admit it".

Open Positions:
Long 1 unit of Ultrashort S&P ticker SDS @ 61.75 stops at $92.43
Long 1 unit of Ultrashort 20yr TBond ticker TBT @ $60.10 stop at $53.93
Long 1 unit of Anglogold ticker AU at $17.90 stop at $15.39
Long 1 unit of Goldfields ticker GFI at $8.60 stop at $6.14
Long 1 unit of Chicago Bridge/Iron ticker CBI @ $11.55 stop at $9.88
Short 1 unit Int'l Bus Machines ticker IBM @ $129.05 stop at $97.71
Short 1 units ticker CRM @ $56.05 stop at $42.12


pirateshipinc said...

The question I pose to the readers is, the supply of homes is radically out of touch with the future population as it begins to shrink according to the census, so how will future generations be able to shore up their mortgage assets? I mean really the decisions that are being made today, are out of touch with the long term future that our country might be needed to repay the trillions that are being borrowed today.

Harleydog said...


I agree, SPX 400 here we come.