Valuations and the Nikkei Bubble
oildog 08-29-2007, 3:20 AM | Post #205518 |
1
You know, it often seems to me this board has an unnecessary aversion towards discussing market valuations. I suspect this is because the people who most often talk about valuations are market-timers, and buy-and-hold indexers generally don't feel the need to talk about market valuations. However, IMO discussing valuations responsibly can be helpful.
A good example of this is Conversation #60199, in which a novice poster raised the possibility (post #50) that the US stock market might behave like the Japanese market since 1989 (
see Nikkei chart). The responses to this post was basically along the lines of anything can happen in the markets and stay diversified. Although that isn't bad advice, it seems to me we can do better.
The Nikkei bear market occurred from a starting point where the P/E ratio on Japanese stocks was 78. In comparison, the P/E ratio on the S&P 500 today is about 17. Just from a naive and back-of-the envelope estimate, for the two to be comparable, the S&P 500 today would have to be at about 6,600 (or the Dow 60,000).
Another angle: Right now, the P/E ratio for the Nikkei 225 is about 21, and the index is down about 50% from the historical peak 18 years ago. Again, a really crude calculation - for the S&P 500 to end up in a similar situation, it would be priced at roughly 700 in 2025. For the index to have a P/E of 21 under those circumstances, earnings of S&P 500 corporations would have to contract by about 60% during the next 18 years. For comparisons sake, starting from the 1929 peak prior to the Great Depression, S&P 500 earnings were basically unchanged 18 years later.
To sum up, it would take something far worse than the Great Depression to make the S&P 500 behave like the Nikkei did starting in 1989. While it's true that anything
can happen in the stock market, and a Super-Depression can't be ruled out, the probability that US stocks will go through a Japan-like event starting from these levels would appear to be exceedingly small.
Best,
Oildog