The Back to the (Stock Market) Future

It seems that when journalists can’t think of anything else to say about the latest slaughter on Wall Street they point out that the stock market is now back to where it was X years ago. It’s not a meaningless comparison.

On Friday the S&P 500 closed at 683.38, up 0.12% over the close the day before. Prior to Thursday, the last time the S&P closed at that level was September 20, 1996. Old guys like me think that was just yesterday, but it was actually rather a while ago. Clinton (the husband) was running for reelection. The internet stock craze was just beginning. Steve Jobs hadn’t returned to Apple yet and Amazon and eBay were both still privately held.

Does it make sense that the 500 largest companies in America are now worth what they were 12 1/2 years ago?

Of course, simple price level is not the only way to judge what stocks cost. Consider price earnings ratio (PE), what you pay per dollar of corporate profits. What the S&P 500 companies will probably earn in 2009 turns out to be roughly comparable to what they earned in 1996. But that’s not apples to apples, because in 1996 the economy was humming along in a boom and today the economy is in recession. (We hope.) To normalize the cyclicality out and get a handle on the gross earnings power of the S&P 500, Yale’s Robert Shiller has popularized PE10, which is the ratio of price to the average earnings over the previous ten years. Plug in Friday’s close to his spreadsheet and you get a value of 11.8. The last time we saw 11.8 was in January 1986.

Other valuation measures point to the middle of the Reagan years. The last time that the S&P 500 had a dividend yield as high as it currently has, according to Shiller’s spreadsheet, was October 1985. And best I can make out from this chart the last time the price/book ratio of the index was this low was 1986. So based on what you get for your money in terms of long-term earnings power, dividend yield, and book value, the market is trading at 1986 prices.

One more historical comparison worth pondering: the dividend yield on the S&P 500 is now safely above the yield on 30-year Treasury bonds. The last time that happened? August of 1958.

It takes a lot of nerve to say it out loud, but all these comparisons imply that the stock market is cheap now. The economy grew quite nicely in the last 12 1/2 years and our biggest companies are larger and more profitable. It’s hard to justify that they have not appreciated in value at all.

The market in 1986 may not have seemed so cheap to those working there at the time (I was in college) but it sure seemed like a screaming bargain in hindsight, at least until very recently. Using a time machine to travel back to the mid-80’s was a recurring fantasy of many stock market investors. (Probably still is, come to think of it.)

And I used to amaze my professional colleagues with the fact that the dividend yield had ever been higher than the long bond yield.

Of course, saying the market is cheap is different from saying you should hurry up and buy in. Just because it is cheap today does not mean that it cannot become cheaper tomorrow. But is it cheap today.

Investing, Robert Shiller | Frank Curmudgeon | March 9, 2009 6:00 am

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