The following, for what it's worth, will only be of interest to those FWers
who invest, or to those who might have lost a great deal of their pension
fund in the last couple of years (as has happened to several million people
in England).
We are now beginning to see all sorts of curious theories by economic
editors in the newpapers attempting to cheer up their readers by showing
that equity prices are fairly nearly the bottom and that it might be a good
idea to think about re-investing and trying to recover their losses. (As it
happens, I disinvested in equities some years ago because I thought [and
wrote so to FW list as older subscribers will attest] that the market was
already mad. But I'm interested in investing when I think the bottom has
been reached because I very much want to help in the education of my
grand-daughters in future years as the state education system over here
collapses completely [university fees will no longer be free and will soon
start to be charged by the Labour Government!].)
There was a recent article in one of our papers recently showing a fairly
close fit between graphs of S&P price-earnings (P/E) ratios between
1919-1929 (the Great Depression) and also the decade between 1990 and 2000
-- when the peak of the former had been re-based to fit the peak of the
latter (P/E = 40). As it happened, the low points on both graphs also
coincided.
The superimposed graphs not only showed a close fit in the run-ups to the
peaks but also, when the bubbles burst, the drop in P/E ratios also fell in
almost identical fashion. On the basis of this graph, the lowest point is
yet to come -- sometime during mid-to-late 2003 when the P/E ratio will be
about 8-10.
Now that struck me as being quite plausible. Unlike Harry, I believe that
P/E ratios are extremely accurate indicators of the health of an economy,
and it's been the case that P/E ratios have always fallen to somewhere
between about 5 and 10 after every major downturn for the past couple of
centuries. So, on the basis of this graph, I was persuaded for a few
minutes that it's likely that recovery will start sometime next year.
However, I realised that there was a fallacy in the editor's argument.
Where he'd been naughty (consciously or unconsciously), and which would
have confused most readers of the graph, is that he happened to start the
current graph at 1990 simply because that was ten years before the crash of
2000. This 1990 datum seemed like the lowest point -- comparable with the
lowest point in the years before the 1929 crash -- because that's where he
started the graph! But 1990 wasn't the lowest point. It was pure
coincidence that when the peaks were re-based and superimposed, then the
share prices (but not P/E ratios) exactly 10 years beforehand were also
very much the same.
But the actual lowest point before the recent crazy period was 1983, when
the P/E ratio was about 8. Thus, a period of 17 years should have been
compared with the 10 years leading to the crash of '29. (Considering that,
today, there are so many more players on the scene -- companies and well as
many more intermediaries and investors -- then it's not unreasonable that
there's much more inertia in the system than previously and that peaks and
troughs are more protracted than in former times.) So, with some clever use
of my photocopier, I not only re-based the vertical axes of the two graphs
so that their peaks coincided, I also re-based the horizontal axes (time),
compressing 17 years into 10 in the case of the more recent graph.
The superimposed graphs are still remarkable similar! (If anything, they
match even more closely than the editor's superimposition.) However, in my
version, the recovery (at around a P/E of 8 , as before) won't take place
until '05 or '06.
Keith Hudson
----------------------------------------------------------------------------
------------
Keith Hudson, General Editor, Handlo Music, http://www.handlo.com
6 Upper Camden Place, Bath BA1 5HX, England
Tel: +44 1225 312622; Fax: +44 1225 447727; mailto:khudson@;handlo.com
________________________________________________________________________
