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Sounds like the Bubble is about to burst.. I wondered if your friend ever
read or heard of Tulip Craze in Holland 400 years ago? If he does not know,
he must not daytrade until he does!
<p>Trade wisely
<br>Gary
<p>"Dennis L. Conn" wrote:
<blockquote TYPE=CITE><style></style>
Just as a follow-up on my buddy's
situation, he now informs me that he's found someone to bankroll an account
to the tune of $100,000 and they want him to daytrade it! He's never traded
<u>anything in his life</u>, unless it was baseball cards!!! His benefactor
has also agreed to pay him $500/WK to do the daytrading AND has agreed
to split the profits 50/50!!!!????!!!!! "It couldn't have come at a better
time", he informed me! Now he can drop his insurance business! As you read
this last paragraph, did your jaw hit the floor as mine did when I first
heard it??? I almost swallowed my tongue!!! Does anyone have anything positive
to say about ANY of this? What the hell is going on here? I can't believe
someone would dump that kind of money in his lap and say, "Here - daytrade
it! Oh, you've never traded? Don't worry about it, how hard could it be?"
Anything this outlandish has got to be a setup - but how??? Could they
yank their money or refuse to meet the margin calls and leave my friend
hanging with more debt than he could ever hope to pay by holding him legally
responsible for the losses that will undoubtedly occur? How many different
ways can this turn out badly??How far should I go now with my concern for
him and his wife and family? Is this as insane as I think it is? I think
I already know the answer to that last question... Dennis C.dlc@xxxxxxxxx</blockquote>
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</x-html>From ???@??? Tue May 25 18:07:56 1999
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Date: Sun, 23 May 1999 12:32:15 -0700
Reply-To: JW@xxxxxxxxxxxx
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From: "JW" <JW@xxxxxxxxxxxx>
To: RealTraders Discussion Group <realtraders@xxxxxxxxxxxxxx>
Subject: MKT: - Article - High P/Es=Low Risk
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Anyone care to comment on the article below? Seems like the author is
saying that as long as P/E ratio's stay high, there is nothing to worry
about.
Article is at:
http://www.bloomberg.com/personal/voices_new99.html
JW
______________________
High P/Es=Low Risk
A noted investor argues that, contrary to conventional wisdom, investors
should buy into markets with high multiples.
By Kenneth L. Fisher, June 1999
Throughout the 1990s, many experts have been warning investors that the
stock market's historically high average price-to-earnings ratios mean that
disaster looms dead ahead. But a serious market decline-a double-digit loss
for the year-hasn't happened so far this decade. It makes one wonder if the
notion that high-P/E markets carry great risk is flawed.
Indeed, it is. Contrary to conventional wisdom, extremely high P/E markets
have never led to a double-digit decline in the Standard & Poor's 500 Stock
Index the following year-not even once. In fact, the historically
highest-P/E markets-those with a multiple of 19 or greater-have generated
above-average stock market returns for the following one-, two-, and
three-year periods. (This is verifiable only for the U.S. market; there are
no comparable long-term data for overseas stock exchanges.)
I discovered this fact following a recent financial conference, where I saw
a fellow display the average annual P/Es of the S&P 500 for every year since
the index was created in 1926. The data was presented as a bell curve. The
few years with the lowest P/Es-10 and below-formed the bell curve's
left-hand tail. The few years with the highest P/Es-19 and above-shaped its
right-hand tail. In the middle of the curve was a big bulge representing the
bulk of years in which the multiple fell somewhere between the two extremes.
At the far right edge of the lecturer's bell curve, the part showing the
historically highest P/E multiples, was this year's P/E of more than 30. The
unusually high figure, he concluded, should make us bearish about the
market's performance.
How wrong he was. My firm has collected data to generate a bell curve that
shows 127 years of P/Es linked to the following year's market returns. (We
also created similar bell curves in which the multiples were linked to two-
and three-year market returns.) We used the S&P 500 and its predecessor, the
Cowles Commission Index, which dates back to 1871. (Scholars created this
retroactive index in the 1930s for Congress, which was trying to figure out
whom to blame for the 1929 stock market crash. If you've read this far, it
should not surprise you that the culprit for the great crash was not a high
P/E ratio; the multiple for 1929 was in the normal range.)
Here's how we crunched the numbers. We noted what the market's P/E was on
every January 1 for each of the past 127 years and then ranked the years
from low to high according to their P/E ratios. Next, we divided the range
of P/Es into 10 groups (or intervals), from less than 8 to more than 25.
This created the familiar bell-curve pattern-with otherwise unconnected
years falling into the intervals according to their P/Es. There are a few
years of very high or very low P/Es on both ends of the curve and a large
number of years with normal P/Es in the middle.
The first interval, at the far left of the curve, shows the various eight
years in which the market's P/E was less than 8. The second interval
contains the 10 years in which the P/E was between 8 and 10. The third
interval contains the 20 years with P/Es of 10 to 12. The fourth interval
contains the 28 years in which P/Es ranged from 12 to 14. This fourth column
forms the peak of our bell curve, and combined with the fifth and sixth
intervals creates the bulge demonstrating that most of the past 127 years
had P/Es between 12 and 19. Forming the right-hand tail of the curve are
four intervals that show the 17 years in which the P/Es were 19 or higher.
When you link the P/E ratios for each of the past 127 years with the
market's return the following year, several empirical truths emerge. Most
startling is that all double-digit calendar-year stock market declines-the
monster drops everyone fears most-occurred when P/Es were below 19. Thirteen
times in the past 127 years the stock market's total calendar-year return
was negative 10 percent or worse. Each of those 13 years appears on our bell
curve's middle to low end of the P/E range. Not once did the market suffer
such a drop when the P/E was 19 or higher.
Do high-P/E markets fall more often than those with low P/Es? No, just the
opposite. Price-to-earnings ratios were below 19 in 110 of the 127 years we
studied, and the market finished in negative territory in 34 (or 30.9
percent) of those 110 years. During the 17 years when P/E ratios were 19 or
higher-the historically high end of the P/E range-the market ended down
three times, or 17.6 percent. Proportionally, the market posted a negative
return less often when P/Es were in the highest part of their historical
range. Moreover, the market's declines in those three years were not
large: -8.7 percent in 1962, -1.4 percent in 1934, -0.4 percent in 1939.
The odds of a stock market decline do not increase when P/E multiples are at
their highest. Quite the contrary-ultra-high P/Es lead to above-average
market returns. The mean return for the 17 years when P/Es were 19 or higher
was 13.5 percent, versus 10.7 percent for the 127 years our data covered.
The median return for those 17 years of high P/Es was 10 percent, compared
with 8 percent for the entire period. And the ultra-high P/E years had a
lower standard deviation: 14.3, compared with 17.6 for the whole 127-year
period.
So there you have it. During the ultra-high P/E years, the stock market fell
less frequently and experienced smaller declines than normal; these years
also posted higher overall returns and below-average deviations.
So far, I've been describing the data that emerge when the market's P/E on
January 1 of any given year is noted and then tied to the S&P's return 12
months later. Are the lessons the same when the stock market's performance
is examined two or three years later? Yes, they are. Using those time
frames, it remains true that ultra-high P/Es led to higher returns, lower
standard deviations, lower frequency of declines, and no monstrous
double-digit declines.
When P/E ratios were 19 or higher, the stock market for the following two
years posted an average annual return of 12.4 percent. When P/Es were below
19, the S&P's average annual return for the following two years was 9.7
percent. When P/Es were 19 or higher, there was only one two-year period
when the market recorded a negative return; during 1938 and 1939, the stock
market fell by 5.2 percent. By contrast, 20 percent of the years with P/Es
below 19 led to two-year net-annualized market declines, including six
annualized double-digit two-year disasters. On a three-year basis, the
annualized return for years in which P/Es were 19 or higher was 10.1
percent; the comparable figure for years with lower P/Es was 9.6 percent.
Tracking the relationship between high P/Es and stock market returns leads
to an obvious question: Why haven't high P/Es posed greater risks to market
performance? The reason is that in the high-P/E markets of the past,
earnings have risen in the following few years faster than share prices.
This process continues until the P/E multiple falls back into the middle of
the bell curve. Then market risk again increases. And in ultra-high-P/E
markets-those in which the P/E was 19 or higher-earnings have exceeded
expectations. That was certainly the case last year, as it is for 1999.
But the belief that high-P/E markets are dangerous is as strong as ever.
Why? The basic fact about the stock market is that it's perverse and
counterintuitive. Trying to maintain a rational point of view is often, for
most of us, a painful exercise. The market efficiently discounts all known
information. Whatever you and your friends know, learn through the media,
and can get buddies to easily agree with is either wrong or already priced
into securities markets. No exceptions allowed.
When the market's P/E is higher than normal, as it is now, every investor
knows it. Even those who don't know what P/E stands for can tell you that
these days the market is showing frighteningly high stock values. Their
resultant fear of heights and concern about the possibility of sustaining a
loss is explained by a behavioral-finance truism: People hate losses much
more than they like gains.
Investors are not risk averse. Instead, they are loss averse. Richard Thaler
and Shlomo Benartzi earned huge reputations in academic-finance circles by
demonstrating that normal investors hate losses about two and a half times
as much as they like gains. In other words, investors feel the sting of a
monetary loss more acutely than they feel the pleasure of a gain. Therefore
they will do much more to avoid losses than they will do to make gains.
Investors will typically take on increased risk if they believe that doing
so gives them a chance to avoid a loss they would otherwise incur. Daniel
Kahneman and the late Amos Tversky proved this insight into investor
behavior in a body of work now known as "prospect theory." Normal investors
confuse actual risk with the perception of risk, while maximizing their
desire to avoid the possibility of a loss.
The perception of a possible material loss associated with lofty
price-to-earnings ratios keeps investors fearful in what is actually a
low-risk market environment. This principle also explains why at the bottom
of a bear market-when the perception of risk is high because of recent prior
losses, but risk itself is actually diminished-few investors decide to add
to their stock holdings.
I am continually amazed at how violently investors react against this
notion, particularly value investors. To avoid considering it seriously,
they grab at any straw to disavow that a very natural bias is wrong. In
rebuttal, they claim the phenomenon occurs because ultra-high P/Es come from
suppressed earnings posted at the end of a recession. Not quite. This
sometimes happens, but it is far from universal. Investors' vehemence that
ultra-high P/Es must have a high risk is just another aspect of the
perverseness of the market.
Will ultra-high-P/E stock markets always carry a low risk? I don't know. But
they will until the majority of investors shed their belief that high- P/E
markets are highly risky.
--Kenneth L. Fisher, the founder and CEO of Fisher Investments, a Woodside,
California, money-management firm and a Portfolio Strategy columnist for
Forbes.
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