Monday, August 15, 2011

Last Week's US Equity Markets & P/E Ratios

On last Wednesday, I wrote this post discussing equity markets performances at the half-way point of the week. Since then, the S&P finished the week at a net loss of just -1.7%. But, of course, this grossly understates what actually transpired.

We saw a week of daily S&P returns of -6.7%, -4.4%, +4.6% and +4.7%. My own volatility measures jumped almost two-fold by the end of the week.

Yet at least one Bloomberg co-anchor attempted to assure viewers that it wasn't such a bad week after all, with such a modest net decline in the major equity averages.

Give me a break. The average retail investor probably bailed out somewhere near a bottom point, no doubt losing about as much as one could. This sort of behavior have been well-documented by Charles Schwab's previously-discussed research.

But I had to laugh at the Wall Street Journal's Money & Investing Section's lead article in this morning's edition. Clinging to hoary old notions of the importance of P/E ratios in a predictive sense, the article focused on recent declines in the 'P,' with forecasted declines in the 'E,' as well. Then there was the requisite nod to trailing versus forecasted earnings, etc.

Too bad none of this actually has anything to do with total returns. My proprietary research has convinced me that dwelling on P/Es is a mistake, since it's a product of primary drivers of performance, not a driver itself.

Further, it's a static measure attempting to capture time and trend. But it can't. Instead, various pundits and analysts ascribe all manner of benefits or drawbacks to using various massaged measures of the numerator or denominator in order to try to give it some rationale and technical luster.

I don't buy any of it.

Rather, I look at my market turbulence signal, and find that it is quite far from registering a market which one should leave, or short. My equity selections continue to nicely outperform the S&P.

For a lot of reasons, developed economies may be entering a period in which revenue growth for top performing firms slows. But, at least for now and the near future, it doesn't appear that it's time to panic if one holds the right equities, or even, for that matter, the S&P500.

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