Guest Post: "So Much For The Market Being Cheap" Charting A 50-75% Downside Case In The S&P

Tyler Durden's picture

Submitted by Brandon Ferro, Managing Member of Hevea Partners

Some Market Thoughts worth Sharing

Historical market data that suggest our current situation resembles very scary periods in times past (i.e., the 1929 crash to be specific) is beginning to pile up.

Let's look at the set up from the perspective of charts.

Here are historical bear markets, indexed to 100% (100% = bull market peak). 

It's quite easy to see that the current bear market that began in late April has been more ferocious than the average bear market through history at this juncture of its development.

In fact, this bear market looks an awful lot like the way the 1929 crash shaped up.  While other individual bear markets have fallen faster and by a greater amount, they were all short-term crashes, such as the 1987 crash and the 1998 Asian Financial crisis crash. 

As such, they ended very quickly.  The current one, however, seems to be more drawn out, again looking very similar to the 1929 crash represented by the red line.

What is worth noting is that despite the fact that we witnessed a mini-crash in May and a $1T support package for Europe thereafter, the current tape action is still as weak as it is and is leading to the set up in these charts I'm discussing. 

Despite the latter events, one of which was supposed to be cathartic to an over-bought market and the other supportive to global economic stability, we're still hanging on the edge of a cliff it seems.

Now, let's specifically compare the 1929-1942 bear market, which began with the 1929 crash and largely ended with US engagement in WW2, to the 2000-2010 period, which has seen two massive bear markets with two major rallies of 100% and 85% in between. 

It is amazing how closely these charts resemble themselves in terms of price action and the timing of each cycle’s respective moves.  It seems to me that the only major difference is the order in which events seem to be playing out. 

For instance, they had their crash quickly while we have avoided ours for 10 years with profligate monetary policy and government spending. 

It seems to me that the market is now recognizing that the game is up; no amount of additional money, bailouts or otherwise can prevent the system from collapsing under the weight of all the debt that has been allowed to build.  That's why it seems as if the far end of the black line is on the cusp of doing what the red line did on the left side of this chart in 1929.

Again, the same events, just reversed - politicians unwittingly took austerity measures in 1929-1930 that caused a depression and they're doing the same thing now, just 10 years later than expected.

If you look at the dotted black line, it represents the absolute low of the 1929-1932 depression, a roughly 85% decline in all on a monthly basis.  For context, this correlates to roughly 230 on the S&P500.

Question is, their bear market ended when we entered WW2; is Iran and Israel the catalyst for a similar situation in 2012 when this analytical work suggests our bear market could end?  They could theoretically pull the world into their mess given the resources at stake and the emergence of a resource rich country in China.

Which brings me to the S&P500 / Gold ratio chart. 

Historically, the value of the S&P500 relative to the price of gold reaches a bottom at roughly 28% (all-time low = 19%).  The ratio is currently 94%. 

Assuming a gold price of $1,500 or $2,000 (reasonable given fundamental backdrop) suggests an S&P500 value of 375-500.

Isn't it crazy to see how the market cycles vs. the price of gold through history?  This is the third major secular bear market for stocks relative to gold over the past 110 years and it shows up decisively in the chart. 

If you believe that everything reverts back to its mean and even overshoots (i.e., when you stretch the rubber band too hard in one direction it has to snap back even harder in the other), then the unprecedented explosion in the market vs. the value of gold in 2000 (almost 6.0 on the chart) relative to other historical peaks at the top of secular bull markets (1929 and 1966) suggests greater upside than $1,500-$2,000 for gold and more downside than 375-500 for the S&P500.

Further, the SPX / Gold ratio chart is where we form our timing thesis of 2012 being a potential bottom for this secular bear. 

Notice how troughs in the S&P500 relative to the price of gold have typically taken 12-13 years to play out.  The S&P500 put its peak in relative to gold 10 long years ago in 2000.  We sure are close.

Let's also look at the valuation on the market (Price-to-Earnings ratio or P/E) when it has typically reached major, major bottoms which have led to new periods of prosperity and huge, secular bull markets.

Typically, the P/E on the S&P500 has reached b/t 6x-8x earnings per share (rolling Shiller 10 year average), well below the current ~19x. 

Notice how the “generational low” in February 2009 (dark black), which preceded the 85% rally over the past year, was probably not the generational low everybody thought it was - the P/E on the market never went below 14x.  Also note the P/E at the 2003 lows (white).

If we assume $70 in S&P500 earnings per share in 2011 (mild recession in 2H10 and 2011) and use a 6x multiple you get an S&P500 value of 420. 

To really nail the overall thesis for you here is a comparison of the P/E ratio on the market during major, long-lasting, secular bear markets.

I’ve indexed the P/E to 100%, the point at which it peaks during the end of a secular bull market.  As the lines move right and lower it represents the amount by which the S&P500’s 10 year P/E has contracted relative to its peak in the past secular bull move.

The black line represents the bear market we've been in since 2000.  The marker represents today's data point. 

As it stands, P/E ratios have contracted by roughly 50% from their level in 2000 (45x, vs. only 35x at the peak in 1929).

Notice how much further valuations have to contract to reach the level of contraction they have reached in other secular bear markets. 

The chart indicates valuations bottom when they have declined about 80%-90% from their high.  Using the 2000 P/E of 45x this yields ~5x-9x, in-line with my chart above which says market bottoms are reached at P/Es in that range.

Let’s play devil’s advocate and assume that S&P500 earnings estimate of $95 (LOL) in 2011 is correct…

Even if it happens, this chart suggests it could be more than offset by material P/E contraction that has yet to take place.  A 6x-8x P/E on that $95 number next year would yield 570-760 on the S&P500, well below the current 1,030.

Therefore, even if you want to make the bull case for earnings, the latter chart suggests you’ve only figured out half the story; you also have to make an entirely unlikely bet that the black line will diverge and we will start to witness massive P/E expansion unlike any we have ever seen before at this stage of a secular bear market.

I’m not saying it’s impossible, but it sure does seem implausible given the way history looks in the chart hah?

So much for the market being cheap.


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bull-market_3.0's picture

Some very interesting points, especially about the 10 year P/Es

Not a big fan of the SPX/Gold Ratio however. If S&P represent the top 500 companies in the US, and Gold doesn't increase in value, it makes no sense that the ratio should be constant given that technological progress should improve the value of the numerator.

Nevertheless the 10 year P/E analysis is interesting and really pisses me off because it suggests to me that I will have to get out of this market again....ughhhh! 

George the baby crusher's picture

Don't understand why your post was flagged as junk.  It's a valid comment and opinion.

ratava's picture

because ZH is full of butthurt people after the latest gold plunge. you cant be a deflationist and a goldbug at the same time, sorry guys.

Papasmurf's picture

$40 drop on $1250 is a butthurt?  You must never have invested in the S&P.

Chemba's picture

regarding the SPY/Au ratio, if the SPY constituents are creating intrinsic value, that just means there would be a secular up-trend in the ratio, but you could (would) still have the cyclical swings about that trend.

regarding p/e analysis, we'll get to those bear market lows but it will take time.   The experiences of most investors today are anchored in the greatest bull and bubble market of all time.  to them, a 15x P/E seems "cheap", and they can't "see" how the credit bubble has fueled "E" to unsustainable levels.

We will get a bear market P/E of 6-8x and it will be on an "E" that nobody can anticipate.  A 7x P/E on $35 of "E" is ~ $250 on the SPY.

When this happens, and it will, the only silver lining is that voters will send the corrupt corporate-socialist (fascist) Obama back to Chicago for some "community organizing"

pan-the-ist's picture

You're not Chemba Wumba.

RobotTrader's picture

If the SPY is going to lose another 50%....

Well, say hello to 5-yr. yields of .70%, 10-yr. yields of 1.8% and 30-yr. at 2.6%.

Jasper M's picture

"Either gold is 3x underpriced, or stocks have 75% downside."

Probably a bit over both.

It pains me to say (hate to risk offending that avatar) I have one quibble with Robotrader's analysis - Treasuries, especially on the long end, will only continue to plummet proportionally Until Federal default is manifest. And, really, how much longer do you think that'll be? 

Not that I'd mind if the rates Do go that low - I am am currently holding a bit of IEI, in the (normally boring) 5 year zone, and any such windfall would be welcome. 

Spitzer's picture

There you go, the biggest bubble of them all.

Its so obvious is sickening

jeff montanye's picture

we've already traded at 2.6% on the long bond (pre-christmas '08).  considering the prior post we may get to only 3.5% or so this run.  nothing like higher interest rates to collapse p/e ratios.

Hungry For Knowledge's picture

THAT is when I'll refinance my house!

Tripps's picture



sp500 at a 11-12 pe on 2010 and 2011 right NOW with HARD data. and was a 10 PE at the 2009 LOWS...when banks were going to zero


what do you freaking bears want? utter destruction. i hope you all get BLOWN out of your shorts for your LYING regarding PE, etc!

you got stocks like verizon paying 7% yields and you want them to trade at 20% yields while treasuries would pay .1%?


the bubbles are in currencies and bonds. wake up. not stocks


Assetman's picture

Stocks with zero yields are vulnerable-- and certainly good handful of the higher beta variety are very bubblelicious.  This is certainly true if earnings growth gets revised downward-- valuations be damned.

Gravitating to stocks like Verizon (assuming they can continue maintaining its dividend payout) can retain a greater portion of its stock value if things go wrong.  Investors will be naturally attracted to the yield if there is a huge premium to Treasuries.

I don't disagree that there is a bubble in bonds, or currencies, for that matter.  But process of seeing that bubble prick may take longer than most expect.

jeff montanye's picture

i'm impressed he's got HARD data for 2011.

pan-the-ist's picture

Here's a newb question:

Why would anyone (in their right mind) bother owning a stock that didn't pay dividends?

Reductio ad Absurdum's picture

Well... growth. Microsoft didn't pay dividends until recently. If you had bought it in 1986 and held for about 13 years you'd have done very very well, all without any dividends.

Also, there are a lot of trendy or opportunistic stocks out there that you might want to get into and out of very quickly, in which case dividends are irrelevant.

obelisks's picture

So do you think now is a good time to buy real estate in Vegas ?

kc135guy's picture

Sorry Tripps, here is the correct information on PEs during that time and an improvement to Shiller data.  Not sure where you get the 11-12 pe - been downloading S&P data for years and haven't seen those yet either GAAP or Operating.

BTW, when asked about a company's future earnings, Carl Icahn replied "How the hell do they know what they will earn next year?"

Thomas's picture

That Icahn quote is spot on. Accounting is still in an atrocious state of affairs (actually the accounting is probably fine; it's the reporting part.) There is also that niggling little detail that percent drops from different p/e's is questionable. In our current case, I think it is the best case scenario. Of course, once stocks lose the p/e ratio, the p will be chasing the e to the bottom.



DoctoRx's picture

You say:

politicians unwittingly took austerity measures in 1929-1930 that caused a depression

There is a reason that the liberal economist Robert Shiller says he admires both Hoover and FDR.  Both were interventionists.  Did not candidate FDR rail against the Hoover deficits and campaign on a balanced budget platform?  Perhaps the Fed's sudden move to high interest rates contributed to the stock crash.  But to blame the Great Depression on 1929-30 "austerity" is questionable.  Whether Smoot-Hawley in 1930 can be called austerity is unclear, rather than unwise under a more modern view than existed in 1930.

It appears that Gentle Ben blames the Fed more than Hoover or the politicians, Smoot-Hawley aside, for the severity of the GD.

In any case, this is not the post's main point, with which I am very sympathetic. 


jeff montanye's picture

your critique is well founded, imo.  fiscal changes were largely expansionary '29 to '32 (fdr elected late '32) and the federal govt much, much smaller relative to gnp.  money supply growth also non-contractionary at 3% or so.  a lot of the contraction was debt run off from excessive consumer, business and foreign government borrowing '14 to '29 combined with the specter of no deposit insurance/bank runs. how this latter squares with the 3% money supply growth that the data show is an area i'd like greater clarity.  wads of money pressed on big banks/wall street while tough times/austerity on main street?

pitz's picture

What's the difference between then, and today?  Back then, money was commodity backed, on some form of the gold standard.  Today, it is entirely floating.  Once you reference both those S&P500 charts with a common commodity, ie: gold, they look identical, and you should see that we are at what appears to be a very low point, perhaps even lower than experienced in the depths of the 1930s.

dehdhed's picture

you can still exchange fiat currency for gold or commodities .. for now anyway

dehdhed's picture

i meant the dollar is indirectly backed by gold

qikbucks's picture

US Debt/GDP = 90% and climbing.. tic .. toc.. 

FranSix's picture

Expecting a crash? Well, we just had a huge stock market crash and bear market rally.  What happens next?  Ok, let's compare bear markets on an inflation adjusted basis:

Looks like a coming denoument that compares closely with the Nikkei.

Johnlaw2012's picture


Aaron Boesky of Marco Polo Pure Investments is calling a 3,500-4,000 point level for the Shanghai market at the end of 2010. If the index finishes this year lower than it is today, he pledges to AsianInvestor that he will run around Hong Kong in his underwear.

By Simon Osborne | 7 July 2010
Keywords: aaron boesky | marco polo | china
The Shanghai index has fallen more than 30% since its recent peak in August last year. Enough already, says Aaron Boesky, chief executive of Marco Polo Pure Investments in Hong Kong, who has made what he claims to be his most high-conviction call ever that this is a market bottom.

Lots of money managers, pundits and hedgemites make bullish calls. We hear them all the time and never punish anyone for getting it wrong. We must and will.

Will Boesky put his money -- or in this case, his trousers -- where his mouth is?

And if you're wrong? What if the market ends 2010 lower than today?
We hold, and continue to try and raise capital, while we await the Chinese investors' return to the market.

Come on, you've just made what you say is one of your biggest calls ever. That doesn't sound like a very big reaction should you get that call wrong...
We will continue doing what we do and investing for the long term in a market we truly believe in...

No, I am not satisfied.
Ok, ok. I will make a wager with you Simon. If we are right in saying the market finishes the year with an impressive rally to over 3,500 points, you tell your readers in a nice piece that we made the call of the year.

If we are wrong and it finishes the year below the July 5 close of 2,475 for the Shanghai A-share index, I promise to run the streets of Hong Kong dressed only in my under-shorts. Is that enough skin in the game for you?

DoctoRx's picture

pitz:  You might be interested in this analysis by Andrew Smithers, which values the stock market both on an earnings and an asset parameter.  Both show it about 40% overvalued, far different from the early 1920s and the early 1930s and at various other times:

maddy10's picture

SPY will be down only if honesty miraculously returns and Mark to market bares real bank balance sheets

NOT happening!

Move on! Muddle in the mud bath!

There will be constant disclosures of filth to keep SPY within range!

Follow where big money goes and prosper!

System is officially biased in favour of biggies!

BobPaulson's picture

I want to agree with this but my scientific mind says n=2, so I wouldn't get too excited about a trend line though that data set (R^2=1.000000000).

ChevronSky's picture

I posted this comment in another thread, but I believe it is relevant to this article as well. CS


For the first time since the start of the March '09 rally, the persistently rising quarterly values have reversed (as of 6/30/10) in the following: SPY, QQQQ, DIA, IWM, RSP as well as most of the individual Dow Industrial components; and GOOG and AAPL if that matters to anyone.  When quarterly values reverse, this indicates that the recent directional bias (in this case, down) is continuing with unusual trend tenacity.  In other words, it indicates a change of higher-timeframe trend, i.e. of Primary degree.  Quarterly values for most major index ETF's began increasing in Q3 2009. Prior to the end of Q2 2010, it was premature to call an end to the Primary bull run that started in March '09, especially for long-term investors.  Now it is not.

Eric Cartman's picture

I've seen this on so many blogs recently that I'm starting to think it was just one whack jobs prediction and a bunch of bears are quickly jumping on board, varying the study slightly and publishing it anywhere they can. 

I star. 

Oh Jesaulenko - you beauty's picture

I posted this elsewhere and it's a bit off-topic, but why did the PPT ever let the SPY get down to 666 last year?  If they let it happen then, why won't they now?

themosmitsos's picture

there was no PPT then silly, PPT was created BEACUSE it fell to 6-6-6, the number of the beast :P

Scooby Dooby Doo's picture

Inside the beltway it's referred to as 'The Reston 6'. Six organizations in the DC area that, in concert, use algorithmic trading to move the market in an agreed upon direction. They take their marching orders from the Fed, not Timmah. Only the Fed can pay for their margin calls and take or make delivery on the contractual agreements.

They have a packet sniffer that sits in front of the exchange boxes. It's disguised as a router and firewall but it uses the router’s ability to log ACL matches in its own buffer in order to catalog the traffic that crosses it.

They know what orders are inbound and have a threshold order size that they trade against.

It's all very elegant. Beautifully architected. It gives me goose bumps standing in the chilled room that houses those servers. Knowing what potential they have. Like being in the same room as a God.

themosmitsos's picture

yet *MORE* go give your shotgun a blowjob it

meanwhile, check out Robert Prechter, ms smiley, calling for DOW<1000:

Misean's picture

All very intersesting...outside of the insipid "austerity measures" comment...a claim without a warrant, but is common Keynsian/Moneterist mythology...but anyway...

My problem is that comparing the US today to the US of the Shitty Depression is an incorrect historical analogy.  The correct analogy is to look at Great Britain of 1920-1940 and US today-ish and US 1920-1940 and China today-ish.

My two cents.

From Italy's picture

Have you seen Marc Faber's "mirror mirror on the wall...." conference from about a month ago? He shows that when you have a situation in which they print money, the stock market stays up even though it will be volatile, and the currency collapses. Gold is going up for this last reason, I don't know if you can always compare graphs from 80 years ago to today. The population was young in the 30's. Today we have a rich world population made up of senior citizens especially in Europe, and of young people in Asia, so you should consider this when you project earnings on 30 year bonds, or before comparing today to the past. Of course Faber assumes they will keep printing, in fact this is the real question.

Eric Cartman's picture

This confused the fuck out of me. 

agrotera's picture

You get the same idea when you look at the history of the DOW, and run a simple regression --you will find the DOW between 2000-3000 and if there is such a thing as reversion to the mean...just sayin...

GoinFawr's picture


The DXY looks all gulliver and pletchoes to me.

Hey Johnny Bravo, you're a self purported TA guy, watcha think? I mean every time you find some minor indicator on the USD/Au chart you can magnify to look even remotely bearish you're 'creeching "TOP" repeatedly in all caps while offering predictions of three-fingered bottoms, so how have you missed this crucial technical? It's not like this DXY H&S pattern is at all subtle; indeed it's as plain as the ass on your head.



Johnny Bravo's picture

The DXY looks all gulliver and pletchoes to me.

Well pip pip cheerio to you.

The dollar is currently in a triangle pattern, with support around 82 if it does a 50% fib retracement, and slightly under 80 if it does a 61.8% fib retracement.

I have no idea what you are talking about as far as a head and shoulders pattern goes.  I think we revisit the 61.8 fib in late 2011, to early 2012.  I think that the rally in the dollar has peaked until we see these levels.

laosuwan's picture

Charts are great for predicting the past.

Charts are just visual representations of historical data points; they do not explain anything or predict the future. Besides, the market is now so corrupt and manipulated you cannot draw any conclusions about anything. The only sure way to measure earnings is dividends. That is what I have learned by comparing Asian companies to American companies. If you find a company with no dividends in my part of the world you can be sure their earnings are fake.


Anyway, like Warren Buffet said, "I stopped charting when I realized I got the same answer turning the chart upside down."

Bam_Man's picture

If you find a company with no dividends in my part of the world you can be sure their earnings are fake.

Or just a "flash in the pan", or a combination of both.

In either case, a very astute observation on your part. 

Johnny Bravo's picture

Computers trade on technicals and charts and that's all you need to know to say that your assertion there is total B.S.

Companies don't trade on earnings as much as they trade on technicals.  75% of the traders on earth are HFTs using technicals.

laosuwan's picture

if 75% of the traders on earth are trading based on technical charts then there would be no uncertainty. This is not the case so charting does not work. It does not matter if traders trade on earnings or not, the fact is that companies with dividends have real earnings. The whole, "we use the earnings to invest in future growth so there are no dividends now" story is like a big screaming white pair of shoes on a timeshare salesman. It says, stay away from this company.