A Time to Buy?

Global stock markets have been pummelled. In fact they have received a drubbing in such a short period of time the likes of which we have not seen in many decades. In times like these the visceral bargain shoppers instincts kick into high gear. Warren Buffet sees value in US stocks and has been buying in his personal account.

Is he right? Is this the right time to buy? Does the scoundrel from Omaha get special deals not available to individual investors? Perhaps, but moping about this does not aid our decision making in the least. The dominating question on many minds is whether the brisk, sharp decline from recent peaks signals a buying opportunity. The answer to this question is an unequivocal No! While there may exist some very short-term counter-trend trading opportunities, such an inverse relationship does simply not exist longer term! If you have any doubts about this fact, you can start your research with my July14, 2007 post About Causation Traps.

This aspect of the market seems to be consistent with randomness. In other words, prices have no memory. Future prices are independent of past prices!

Is there then any metric by which we can gauge buying opportunities? I think the answer to this question is a limited Yes. We can use a very simple metric – PE Ratios. Before you start protesting take a look at my review of PE-Ratios versus returns posted on June 6, 2007 and June 8, 2007.

So where are we today. Are we staring a buying opportunity of lifetime in the face? Well, you be the judge for yourself. But here is what the current S&P 500 PE ratio is telling us.

As of September 30, 2009 Standard & Poor's shows 12-months trailing 'as reported' earnings of $50.21 for the S&P 500 index. The S&P 500 index closed at 908, which gives us a PE ratio of 18. Going back to the June 6, 2007 About PE ratio post we obtain an expected return of 48% over a five year holding period. This is not the buying opportunity of a lifetime in my book. There is no guarantee for a 48%. As a matter of fact, the probably for a much lower return than 48% is high.

So it goes...