When is it worth stepping back into the US market as a foreigner (in a broadly diversified drip-feed way)? With the S&P 500 now sitting 50% below its peak you could be forgiven for thinking there might be a bargain out there.
Here are some things it might be worth taking into account:
- market valuations
- currency risk
- appropriate indicators like risk aversion
- average length of recessions
Not on this list are technical indicators – apologies, basically we are not amongst the true believers.
Market Valuations on the S&P 500
Market valuations on the S&P 500 had it on a forward concensus PE of around 12 at the end of September putting it around 11. Since then it has dropped another 10%+ (end of September S&P 1099, today Oct 9th 984). However some estimates have it on a forward basis of 15 or even 19 or higher (at the $48 a share earnings estimate mentioned in this article on the Big Picture blog) on the basis that analysts have been known to be over-optimistic about earnings …
15 actually might well be the long run average but in previous recessions PEs have actually got down to 10 (see this article to see historical PE fluctuations) implying a further fall might be entirely possible.
Currency Risk on US Equities
One would think that in the medium term the $700 billion bailout last week is not good news for the US dollar (for example, it will represent a 24% increase in the 2008 US Federal Budget):
“total government commitment and proposed commitments so far in its current and proposed bailouts is reportedly $1 trillion compared to the $14 trillion United States economy” [Wikipedia]
However in the short term there has been a flight to US dollars in relation to UK sterling and Australian dollar by around 12% and 30% (!) respectively (it is likely the A$ has been punished by the fall-off in commodity prices as well as general risk aversion).
At the risk of trying to predict the future of currencies (a mug’s game as everyone from Warren Buffett to your neighbour Frank can tell you) one would have to wonder when the immediate perceived risk related to bank solvency starts to decline whether the $US is in for a fall – essentially this bailout has given everyone a new reason to dislike it.
How risk averse are equity investors at the moment?
Very averse … The VIX volatility index aka ‘the fear gauge’ which measures the cost of options hit a record high yesterday (Oct 8th) and this kind of VIX level has previously been associated with market bottoms.
Average Length of Recessions
The ‘average’ recession is about 12 months but on the plus side it does seem that recessions have become both less frequent and milder (see NBER study information in previous link). Is the current credit squeeze different – almost certainly – but equally there are many other things that are different in 2008 as well, ranging from technology to world trade.
The ‘Bottom Line’ – buy the S&P 500 now or wait?
At the moment I am inclined to wait. Mainly because I would like to see the US dollar come off a bit as opposed to any other reason. However the other indicators are looking pretty positive. It is of course impossible to pick the exact bottom but if you were within say 15% of the bottom in 2002 you still would have been up 50% within say two and a half years.
Posted under index trackers, market timing
This post was written by mike on October 9, 2008
