Sunday, November 2, 2008

Time to buy?

David Leonhardt gives a mixed picture on whether this is the right time to re-enter the equity markets, with the graphic below. The PE calculated using the earnings for the past 10 years (as against the previous one year) show that US markets have now fallen slightly below the long term historic average.

However, there are strong reasons (and this applies to India as well) to argue against the "time to buy" contention

1. The last couple of decades have seen an extraordinary bull market across the world, that catapulted equity valuations to historic highs. However, when seen from a historic context, PE multiples are only now at reasonable levels, and during previous downturns the PE valuations have fallen much below the historic averages before the turnaround started.

2. The corporate earnings have hitherto been robust, and are only now showing the first signs of flagging. Any recession will drive down earnings and therefore put downward pressure on equity prices.

But as John Bogle points out, the very behavioural psychology that contributed to the long bull market may itself ensure that the rebound takes place sooner than later. If an impression (or sentiment) gathers strength (and as we know, this does not require any dramatic change in market fundamentals, but only a sudden shift in collective expectations) that the markets have bottomed out and there are cheap buys available, that alone may be enough to support and sustain prices for the immediate and medium term future. The fast gathering belief among many prominent opinion makers like Bogle, makes such turnaround in investor sentiment increasingly likely in the immediate future. And, of course, there are the falling interest rates that makes equities naturally attractive.

Update 1
The falling equity markets need not necessarily make the equities any cheaper, especialy since earnings are also falling at the same rate.

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