That Was The Week That Was

THE BE YOUR OWN ECONOMIST ® BLOG

“That Was The Week That Was” was the title of a television program many years ago. This was a week that many investors would like to forget.

What happened to the stock-market rally? Did it fade together with hopes of a second-half economic rebound?

Consider the following chart.

The Stock Market, Earnings Per Share and Price/Earnings Ratio

(Click on chart to enlarge)

Recessions shaded

The stock market (S&P) peaked at roughly the same level in 2007 as it had in 2000, but earnings per share (EPS) improved by more than half in those years. Since the Price/Earnings (P/E) ratio = S&P divided by earnings per share, and earnings per share increased from 2000 to 2007 while the stock market didn’t, the P/E is now back to the normal range it enjoyed before the late 1990s dot.com boom and bust. The P/E had risen to speculative levels during the dot.com frenzy, but has receded from those irrational heights.

Note, however, that the P/E ratio is still closer to 20 than to 10 and higher than the post-WWII average of 15 that prevailed before the dot.com boom. If the stock market is to improve, earnings per share or the P/E - or both – will have to rise. How likely is that?

The financial crisis may or may not be over, but the damage done to the economy by the housing bust is not over. It seems that most days carry another report of housing’s woes. Home prices have a ways to fall. There are also more reports of the automobile industry’s difficulties. It’s hard to see how the economy can go north if housing and autos continue south.

Maybe the federal government’s economic-stimulus package and the Federal Reserve’s low interest rates can work wonders. Maybe….

Meanwhile, if the economy remains in the doldrums, why should earnings or investor enthusiasm – as measured by the P/E - improve? And without their improvement, the stock market can’t climb.

The events of the past week give little cause for optimism.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann