Friday 20 May 2011

Irrational Exuberance and LinkedIn – History of Severe Real S&P 500 Stock Bear Markets – May 2011 Update

I couldn’t believe my eyes yesterday when LinkedIn (LNKD) had its flotation on the stock market.  All that I could think of during the day was irrational exuberance, the market can remain irrational longer than you can remain solvent and how quickly people forget.  For those that missed it LinkedIn floated at $45 per share which valued the company at $4.25B.  With earnings last year of $15.4M I calculate that as a Price Earnings (PE) ratio of 276.  That was shocking enough when you think that the long run cyclically adjusted PE (CAPE or PE10) for the S&P500 is 16.4.  However what I couldn’t believe was that during the days trading somebody or something (High Frequency Trading?) paid $122.70 a share for a PE ratio of 752 which is 46X the S&P500 PE10 long run average.  To me as an Average Joe this sounds like the dotcom days all over again.  The amazing thing is that it looks like plenty of others have already forgotten about the dotcom boom and its after affects in around 11 years and what’s even more amazing is that as I show today in Real (inflation adjusted terms) the market is still some 31.4% below the S&P500 real high of August 2000.  So we haven’t even recovered from the last lot of irrational exuberance.

As always when I review the History of Severe Real S&P500 Stock Bear Market today’s first chart shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market from which I have identified three historic severe stock bear markets.  These I am defining as stock markets where from the stock market reaching a new high, it then proceeded to lose in excess of  60% of its real (inflation adjusted) value.  These are best demonstrated by the second chart which shows each of these stock bear markets and the fall in percentage terms from the peak.  So briefly what were these bear markets with the full background here.
The first severe stock bear (marked in purple on the chart) market started with a new real high being reached in September 1906 and incorporated the 1907 Bankers Panic.  From the high it took until January 1920 for the stock market to reach a real loss of 60.9% and then until December 1920 to reach its real low of -70.0%.  That’s a period of 14 years and 3 months.

The second severe stock bear (marked in blue on the chart) market started with a new real high being reached in September 1929 and is obviously the period of the Great Depression.  The markets passed through -60% on a number of occasions.  In June 1932 the market reached its real low of -80.6%.  That’s only a relatively short period of time however it really wasn’t over then as the market never really recovered and kept dipping back below -60% in real terms.  20 years later the market was still below the real -60% mark.

The third severe stock bear (marked in olive on the chart) market started with a new real high being reached in December 1968, incorporated the stock market crash of 1973 to 1974 and the 1973 Oil Crisis.  From the market high it took until March 1982 for the stock market to reach a real loss of -60.9% and then until July 1982 to reach its real low of -62.6%.  That’s a period of 13 years and 7 months.

Now let’s update the real bear market that we are currently in.  This period began in August 2000 with the Dot Com Crash however we were unable to reach a new real high before the Global Financial Crisis took hold.  In this real bear stock market we have been unable to break through -60% ‘only’ reaching -58.6% in March 2009.  That is a period of only 8 years and 7 months.  

As the second chart shows today we now are struggling to break through the -30% line and as of yesterday’s market close we stand at -31.4%.  In fact the price today in inflation adjusted terms is around the same as we saw back in October 1997.  So in 13 and a bit years we have seen absolutely no capital gain other than fake gains brought about from the devaluation of money through inflation.  Of my 4 bear markets this current one now seems to be the last man standing with the 1906 bear market (purple line) now also heading downwards at a fast rate of knots at an equivalent period in time.  We are now 10 years and 10 months into this severe bear market which is a relatively short period of time compared with the other severe bears shown.  The previous bears all went below -60% in the years to come and at this point were:
-          in 1917 at -40.6% and over the next year heading to -56.7%. 
-          in 1940 at -62.1% and over the next year heading to -63.3%. 
-          in 1979 at -51.5% and over the next year heading to -53.8%.

So while they were in very different places today they were all still heading towards the -60% line and in some instances the -70% line.  This bear market also has plenty of time to make -60% or worse and given what’s happening out there in the real world with some countries getting closer and closer to default I wouldn’t be the least bit surprised to see it.

As always do your own research.

Assumptions include:
-          -Inflation data from the Bureau of Labor Statistics.  April and May 2011 inflation is extrapolated.
-          -Prices are month averages except May 2011 which is the 20 May 2011 S&P 500 stock market price of 1343.6.
-         - Historic data provided from Professor Shiller website.


  1. Excellent work RIT.

    I don't have time to jot down all my thoughts on this but I agree with the general idea that it can take far longer to recover from very overpriced markets than most people realise. However, if you're right that there are further down-legs to this long bear, that's only a good thing for savers as they'll be able to buy the market at lower and lower prices.

    As for your severe bears, I might be inclined to count only three. Looking at the 1906 peak, the 1929 bubble only broke through it for 3 or 4 years, ditto the late 1930's peak. An argument could be made to say that the bear actually went from 1906 to about 1954, or 48 years! This same level was then 'support' for the 1981-2 low. On that technical basis it's reasonable to assume that we might get back in real terms to the levels seen at the peak of 1968. If we got there in the next 10 years then that really would be the opportunity of a lifetime like 1932 or 1982. Perhaps 2022 will be the same?

    Even though I'm not 'technically' minded I think the same argument could be constructed from a CAPE point of view.

  2. Hi John

    Thanks for your thoughts. Interesting point you make about the possibly of only 3 bear markets. Although for future blog posts I think I'm going to stick with 4 as the selection criteria was simply - did the market reach a new high. It did so it counts. Not much thinking involved I know however as you know I try and take all thought out of my analysis so that all emotion is also taken out.

    Picking up on your support level idea though and combining this with the CAPE. The 1920 low gave us a CAPE of 4.8. 1932 gave us a CAPE of 5.6. 1982 gave us a CAPE of 7.0. In contrast this bear since 2000 has only given us a CAPE low of 13.3 in 2009.

    Now if I pick up on your idea and say that tomorrow the market fell to the 1968 real price of 683, as you suggest, we would see a CAPE of 11.7. So lower than 2009 but still a lot higher than the CAPE's of the previous periods but still a very believable possibility.

    As an aside to get the CAPE down to the 4.8 of 1920 the S&P500 would have to fall to 280. Now that really would be blood on the streets. To be honest I'm hoping that doesn't happen even though it would be the opportunity of a lifetime.