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« Mark-to-Market: Prospects for Change | Main | ETF Update: Still no Sector Leadership »

March 11, 2009



A.N. I agree with you. At least a sense of value gives some idea of when to start buying. The valuation debate has played out pretty much as I suspected, especially with backward earnings.

And no, I never got to the final planned part of the series. Events moved too swiftly, and other ideas seemed more important.

Thanks for you good comments.



Hello Jeff,

I don't think that any serious student of valuation claims that it can "predict the bottom". All valuation does is tell you what earnings power or asset value you are getting for your money.

By the way, did you get around to that "technical bottom" piece? My view is that even if "market feel" or technical analysis can give good odds on calling a bottom, this is useless once the market is up 10% or so and the panic has cleared. So, even a great bottom picker is basically making 5-15% in a few days/weeks, once every 4 years at a major market low. That's not a great annualized return.


Mike C - I have some notes that showed everyone looking to technical analysis, since nothing else was working. The TA guys -- at least several of them -- were saying that below a certain level there was no support. It was the last element of the bottom-searching problem.

The market started the rebound before I could do the last part of the series. I am not sure if I will post it.

Thanks for noticing! I have a few other hanging agenda items.


Mike C

Searching for the Bottom: Technical

Is this still coming? Or did you shelve this?

Account Deleted

I bought my house a year ago and the discount on the morgage was only for a year so it is about to run out. My financial advisor has contacted me about re-mortgaging and I have a meeting on monday. She has told me to get a valuation before then if possible to see if the value has gone up as this would help get a better mortgage deal. How do I get one? I need a written copy of the valuation.

Trevor @ Financial Nut

I'm so impressed with our thorough and comprehensive your posts are. Keep it up. That's actually not very common. :)


Mike and Mark,

I think there may be a simpler explanation for multiple compression, one that's independent of interest rates: the longer a secular bear market continues, the greater the number of investors who give up on stocks. So it takes lower P/Es (and higher dividend yields) to attract the fewer remaining equity investors.

In any case, independent of the valuation of the market as a whole, there are individual stocks that appear to be unambiguously cheap today, e.g., profitable companies trading for less than their net cash.

Mike C

@Dave, Mark

Yes. In fact, an ongoing debate/discussion (in a variety of places including this blog) is "how far back" does one have to go to make historical comparisons and is going "too far back" irrelevant? I think it can be argued persuasively that in fact the most appropriate comparison is in fact the 1930s/1940s which is the last time the U.S. really experienced this sort of deflationary/deleveraging contraction as a result of a massive bubble in credit/debt. Therefore, maybe we need to look way back for appropriate stock valuations rather then just the past 20 years.

In the spirit of sharing, a few valuation notes I came across the last 2 days:,%20Andrew%20Smithers%20Interview,%20January%2030,%202009.pdf

Smithers is the Tobin Q guy. I am optimistic about future equity returns from today's level given that the guys who correctly identified the market as overvalued in 2006/2007 now believe it is undervalued.

Mark A. Sadowski

I've been confounded by the fact that most analysts don't consider the fact that the relationship between interest rates and P/E ratios was rather poor before the mid-1960's. The relationship seems to break down during periods of low inflation/deflation. In the Great Depression for instance the 10-year rates dropped to about 3.5% in mid-1932 and yet ten year average inflation adjusted P/E ratios fell below 6. That's why I've felt that the S&P 500 will drop below 400 before the end of this bear market. Thanks for the link to Katsenelson's PDF slides.


"The "trough multiple" concept is currently used in error. Past trough multiples came when interest rates were in double digits. If the interest rate is 20%, the P/E multiple must be 5 just to get fair value. With the current low interest rates, the multiple on forward earnings should be higher. If one takes a corporate bond rate of 8% or so, you should still have a forward earnings multiple of 12.5, and that is building in plenty of risk."

P/E multiples don't show this correlation with interest rates if you go back more than a few decades, and thus aren't likely the cause of multiple compression, as Vitaliy Katsenelson demonstrated in his research on secular market trends. See, for example, his chart which accompanies this recent post of mine, "Stocks for the (Very) Long Run". In 1950, at the end of the secular bear market (or secular "range-bound" market, as Katsenelson calls it) that followed the Great Crash, the S&P traded at a trailing P/E of about 7x, and this was during a period of historically low interest rates.


Mike C - I'm not sure how to improve on the conclusion I wrote. Valuation has been no more help in finding a bottom, this time, than a number of other methods.

I did not link to Barry's article on this occasion. I agree with his basic argument, that earnings are an unknown. I often referred to the Fed model result as a long-term sentiment indicator. If you actually look at data, you will see that bottoms up analysts were better than pundits or top down analysts for years.

I think we should be careful of drawing too many conclusions about methodology from what happened last year. A lot depended on the Lehman decision, as you can see from looking at any data series on stocks or the economy.

I want to emphasize that the point of this article is part of a series explaining why investors do not have their normal reasons to buy, and the bottom is therefore difficult to find.

As you may have noted, I have not written much about valuation since it has been pretty much irrelevant in the face of a lot of other factors. That will be the occasion to discuss the methods of your favorite analysts. There will be a day where the advantage of looking forward will be very clear.

Thanks for a (typically) thoughtful comment.


Mike C

A few questions:

1. What is the purpose of valuation? To call/identify a specific bottom price? Or to identify an entry point where the long-term investor (7-10 years) is likely to achieve average to above-average returns (unlike the previous 10+ years)?

2. Regarding forward earnings and interest rates, what does the past 12-24 months tell us about the practical utility of these metrics?

Weren't stocks (as measured by the S&P 500) "cheap" based on forward earnings and interest rate comparisons at the Oct 2007 peak before losing 55% of their value?

Is it time to bury this model?

3. "Simply put, there is no one else in the valuation debate who is dealing with the issue on these terms."

Kass's method seems very reasonable and sensible to me, but I think the above statement is questionable. Essentially, he is doing the same thing as Hussman or Grantham which is to make some attempt to normalize for long-term trend earnings based on the business cycle so that you do not make the mistake of overweighting either the peak of the business cycle as many did in 2007 or make the mistake of overweighting the trough of the business cycle as many gloom and doomsters are doing now.

"Our main conclusion is the following:

Valuation methods are not helping the average investor."

I had been looking forward to this particular note on valuation, but I'm left scratching my head wondering what you are ultimately saying here. That valuation does NOT matter, or that any model is as good as any other model.


No need to decide which of the three it is ... yet. Just need to respect the price action and the truth will out itself in a few. I think this thing has legs for at least a week or more.

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