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How Cheap is the Market?

Monday, May 29, 2006 | 04:30 PM

This is the first part of a two part series asking the question, "How cheap is the market right now?" (part II is here).

The answer might surprise you. It certainly raises some very interesting questions as to what cheap is, the importance of having a long term perspective. It also begs the question of how much patience long term investors have when it comes to thinking about various metrics.

The question itself involves a combination of data analysis and opinion. To fully explore this issue, we will listen to two different perspectives on the subject: One says the S&P500 is cheap, the other asks, how much cheaper might it get?

For part one, we go to Eddy Elfenbein of Crossing Wall Street: Eddy observes "S&P 500 is now trading at just under 16 times trailing operating earnings. The P/E ratio hasn't been this low since October 1995." Note that he references actual trailing earnings. This is more accurate than using forward forecasts, which tend to be very wrong at key turning points.

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SPX 500 Trailing Earnings at 10 Year Low
click for larger chart

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Eddie also notes that "What was unusual about the rally that began in March 2003 is that it came well after the bottom in earnings."

Note, however, the P/E continues to decline, even as the market rallies. This is consistent with my own views of P/E multiple compression (see this 50 year P/E chart).

Tomorrow, we hear from a hedge fund manager who will point out what this means historically.

Source:
The S&P 500's P/E Ratio is at a 10-Year Low
Eddy Elfenbein
Crossing Wall Street, May 26, 2006
http://www.crossingwallstreet.com/archives/2006/05/the_sp_500s_pe.html