You may have noticed noticed this already, but yesterday the SP 500 finished at the same level that it did exactly three years earlier. That’s the day President Bush signed the $700 billion financial bailout bill into law. And when I say “finished at the same level,” I mean, exactly the same price, down to the last two decimal places.
In fact looking over the last four years, the market hasn’t really moved much at all from one year to the next, has it?
Oct. 3, 2011 1099.23
Oct. 1, 2010 1146.24
Oct. 2, 2009 1025.21
Oct. 3, 2008 1099.23
(Oct. 3 fell on a weekend in 2009 and 2010.)
In fact, if you play with the dates just a tiny, tiny bit, you can make the market look even more humdrum over that time period. Voila:
Oct. 3, 2011 1099.23
Sept. 8, 2010 1098.87
Oct. 15, 2009 1096.56
Oct. 3, 2008 1099.23
Now, Do These Numbers Mean Anything?
Well, in the hands (or better yet, mouth) of a trained financial pundit, they could be made to sound like something meaningful. A recent cartoon plucked by Nate Silver from the clever web comic XKCD for his wonderful “538” column in The New York Times shows exactly how.
The cartoon by Randall Munroe bears the caption “All Sports Commentary,” and it is, for those of us that fancy ourselves as Moneyball-esque amateur sabermetricians, hilarious: Two stick men, apparently TV sports commentators, sit behind a desk; the first one says, “A weighted random number generator just produced a new batch of numbers,” to which his stick friend/co-host replies, “Let’s use them to build narratives!”
It could just as easily have been called, “Too Much of Stock Market Commentary.”
Let’s Write a Narrative!
If you want to come up with a narrative about why stock market valuations are at exactly the same point they were the day the bailout bill was signed — and roughly the same spot as the nearest market date in the two intervening years — go right ahead. Here, try this out for size.
CNN reported on that day, “Federal Reserve Chairman Ben Bernanke said he welcomed the news. The legislation is a critical step toward stabilizing our financial markets and ensuring an uninterrupted flow of credit to households and businesses.”
Say what you want about Bernanke, but, man, did he nail that one or what? Have the markets ever been so stabilized as they must have been over the past three years looking at the numbers above?
Of course, such a narrative ignores the spectacular volatility in the meantime, which saw another 35% plunge from the October 2008 level, the market doubling from there, and coming back down 20% afterwards.
If you want to ignore all that narrative, it’s just as easy to create another, like one about the utter failure of the bailout bill to produce any positive results in the market to date. Pick your economic or political opinion, pick the numbers on the right days that support your point, and you’re good to go.
Here’s a Better Narrative for Investors
Right now, on a daily basis, the market is much more defined by its excess volatility, rather than an utter lack of it (which the above numbers distortedly imply). But neither great volatility nor the lack of it strongly correlate with what a long-term investor is likely to gain from making investments in the market.
Those gains (or losses) are more or less determined by keeping your costs low in two dimensions:
- Buying stocks when the market prices earnings cheaply
- Keeping investment trading and management costs low
As of yesterday’s close, assuming projected quarterly earnings come in around analyst expectations for the third quarter, the SP 500 is trading at a price/earnings multiple of 12.5, the lowest trailing multiple for the market since mid-1989 and lower than its long-term average of about 15.
What happens if we have another recession? Consider this: Following the mid-1989 point, the country was hit with a recession in 1990-’91. SP 500 earnings declined over each of those years, yet the market (with some volatility, of course) moved up mildly. More importantly, investors experienced better-than-average historical returns over the following decades.
Better-than-average historical market returns (which, remember, are 6.5% after adjusting for inflation and before adjusting for costs) are by no means assured merely by finding times when the market is trading at a below average multiple to earnings. But your odds do improve under those conditions. And there are certainly worse narratives out there today than that one.
Bill Barker is a senior analyst for Motley Fool Asset Management.