Posted on: Friday, September 21, 2001
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??Stock Market Quiz??

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Let’s step back for a moment to evaluate the financial and economic conditions prior to the terrorist attack

Let’s step back for a moment to evaluate the financial and economic conditions prior to the terrorist attack. After we contemplate the environment we will have the quiz.

1.      The largest financial bubble in history burst 18 months earlier and $6-7 trillion of wealth was wiped out in the U.S.($11-12 trillion worldwide)

2.      Earnings for US Corporations were declining sharply. Reported earnings for the S&P 500 ended the year 2000 at $50 per share. Just before the attack they were revised down to an estimate of $35 per share for 2001 and still declining.

3.      The current account trade deficit was running at record levels of over $400 billion. Because of the deficit there were large foreign holdings of US dollars. Most of those dollars were invested in the U.S. stock and bond markets. If they decide to sell, it will drive the dollar lower, which would complicate the Fed’s easing policy.

4.      Public participation in the stock market has never been greater. Of the $4 trillion in equity mutual funds, $3.75 trillion came in through purchases or appreciation during the 1990’s capping off with the climactic purchase of $130 billion in the first quarter of 2000 (by far the largest quarterly purchase ever of equity mutual funds). This enabled mutual fund managers to add to positions in Cisco, Oracle, Lucent, Priceline, Amazon, Internet Capital Group, and CMGI at the worst possible time.

5.      Consumer and business confidence were collapsing based upon all the different services that measure them.

6.      Debt levels in the corporate and consumer sector were at record highs by a wide margin.

7.      Corporate layoff announcements were unprecedented.

8.      The second largest economy in the world, Japan, was mired in a recession and Europe and South America (especially Argentina) were following them. The U.S. was also probably already in a recession.

Now the Quiz--With all of the above conditions---before the terrorist attack---  What was the stock market valuation level (based on P/E multiples)?

1)     Higher than every other market peak in history, including 1929, 1972, and 1987?

2)     About the norm of the past 75 years?

3)     About the levels that existed during the bottom of bear markets (or P/E’s at market troughs)?

The answer is # 1. Believe it or not. We sent this fact to Ripley and he didn't believe it! Why would the market sell at more than normal valuations under these conditions? The terrorist attack makes these conditions a lot worse, so you would surely think the stock market will eventually fall to at least normal valuation levels. This level, according to our Limbo, Limbo model (on our home page)would bring the S&P 500 to no more than 700, a full 27% below today's close. (See attachment below)



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