There’s still plenty of time for -60% – History of Severe Real S&P 500 Stock Bear Markets – November 2010 Update

I haven’t updated my History of Severe Real S&P500 Stock Bear Markets since August 2010. At that time QE Lite had only recently been announced. That strategy kept the dead US patient alive for 3 short months before the next load of stimulus, Money Printing 2 (sorry Quantitative Easing 2). Let’s put the $600 billion involved in QE2 into perspective. It’s the equivalent of $1,950 for every US man, woman and child. I was always taught “that nothing comes for free”. In parallel to this I also can’t help but think about Newton’s first law, “every action has an equal and opposite reaction”. As an Average Joe I’m just wondering what the penalty and opposite reaction will be. I guess time will tell but I still can’t help thinking it’s not going to be good.

It must be nearly bonus time and the S&P 500 cyclically adjusted PE (PE10 or CAPE) – November 2010 Update

If you’re a bank, particularly a bailed out tax payer owned bank, who’s about to pay out £7 billion or so in bonuses (which is the equivalent of £113 for every man, woman and child in the UK), while everyone else in the country is going through austerity and slowly being made redundant, then you have a seriously hard sell on your hands if you don’t want to be lynched. Before announcing the bonuses you need to get your PR machine into gear and show the general public that you’re not immoral or greedy but instead a warm and loveable organisation who cares about the general public and wants to help society as a whole.

The PE10 nears its 80 Percentile - S&P 500 cyclically adjusted PE (PE10 or CAPE) – September 2010 Update

Standard and Poors is showing, with 99% of earnings data available, that the Q2 2010 earnings per share for the S&P 500 will be $19.68. That’s a long way from the -$23.25 we saw in Q4 2008. This then has Standard and Poors all excited as they are now estimating that earnings for Q2 2011 will be $21.43 which is a year on year increase of 9%. So no predictions of a double dip recession there.

Why in this world do people always continually assume that because you have earnings of x this time that next time earnings will be x + 10% or so? My company does the same. You have a great year this year so the expectation is that next year you will have a great year plus another 10%. They do the same thing with turnover targets. To me this just seems nigh on impossible as eventually you end up so far up the exponential growth curve with it compounding year on year that you are almost destined for failure. Also where is this additional growth coming from? The world is not growing at 10% so the assumption must be that you are taking market share from someone else. But with the S&P 500 you have on average 500 companies all growing earnings by 9%. That doesn’t seem sustainable. I guess a good example of this is Nokia and the rise in competition from Apple and also the Android Operating System phones. I wonder if Nokia’s board was up until a couple of years ago forecasting this never ending exponential growth also? Now the flavour of the month is Apple but for how long?

The Lost Decade – History of Severe Real S&P 500 Stock Bear Markets – August 2010 Update

At my first post on this topic, back in January 2010, looking at severe real S&P 500 bear markets I postulated whether once the governments of the world stopped stimulating their economies through borrowing and quantitative easing whether we could see a real -60% bear market from the previous high within this economic cycle. Well as I highlighted here there still seems to be life in governments (or their agencies) yet with the recent QE Lite announcement.

Interest rates at 0% haven’t worked, QE hasn’t worked, will QE Lite - S&P 500 cyclically adjusted PE (PE10 or CAPE) – August 2010 Update

In an attempt to try and force a recovery in the US the Federal Reserve have decided that they will undertake “QE Lite” which will entail using the proceeds from maturing mortgage bonds, which were bought using Quantitative Easing (money printing in my books), to now buy long dated government debt. I guess they are hoping that this will force bond yields down further which will reduce borrowing costs across the board for the average punter. I’m thinking two things:

A History of Severe Real S&P 500 Stock Bear Markets – June 2010 Update

I first started posting today’s charts back in January 2010. I ended that post with “My question is once the governments of the world are forced to stop stimulating the economies through borrowing (for example a bond market strike) or quantitative easing (for example excessive inflation) could we yet see that real -60% bear? History suggests there is still plenty of time for it to occur.” Well that day could be now be upon us. We know that many countries out there are today all but ‘bankrupt’ or in the very least are now talking about and implementing austerity measures. So that writes off stimulation via borrowing at least for the moment. I assume that some countries out there would have another go at borrowing if they really needed to although it would be interesting to see what sort of treatment the bond markets would give them this time around?

US (S&P 500) stock market including the cyclically adjusted price earnings ratio (PE10 or CAPE) – June 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on buy & hold and asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller however I also incorporate earnings estimates up to the PE10 month of interest. Background information here.

A History of Severe Real S&P 500 Stock Bear Markets – May 2010 Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market 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, they then proceeded to lose in excess of 60% of their 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 (full details here).

US (S&P 500) stock market including the cyclically adjusted price earnings ratio (PE10 or CAPE) – May 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on buy & hold and asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller however I also incorporate earnings estimates up to the PE10 month of interest. Background information here.

A History of Severe Real S&P 500 Stock Bear Markets – April 2010 Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market 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, they then proceeded to lose in excess of 60% of their 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 (full details here).

US (S&P 500) stock market including the cyclically adjusted price earnings ratio (PE10 or CAPE) – April 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on buy & hold and asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller however I also incorporate earnings estimates up to the PE10 month of interest. Background information here.

Are we back to blowing asset bubbles already?

Last week saw Alan Greenspan interviewed as part of the Financial Crisis Inquiry Commission. The Times reported that during this interview “Mr Greenspan denied his policies encouraged the type of risky lending that spurred the financial crisis. The long-time Fed Chairman - whose reputation has been deeply undermined by the crisis - denied low interest rates and loose regulation had encouraged lenders and borrowers to take ever greater risks."

A History of Severe Real S&P 500 Stock Bear Markets – March Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market 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, they then proceeded to lose in excess of 60% of their 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 (full details here).

US (S&P 500) Stock Market – March 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on buy & hold and asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller however I also incorporate earnings estimates up to the PE10 month of interest. Background information here.

A History of Severe Real S&P 500 Stock Bear Markets – February Update

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market 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, they then proceeded to lose in excess of 60% of their 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 (full details 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.

So that brings me, as always, to the last line on the chart marked in red which shows 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 clearly shows we have now dipped back below the -40% line to be at -41.9% from -39.4% last month. We are now 9 years and 6 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 1916 at -25.4% and over the next year heading to -33.8%.
- in 1939 at -50.7% and over the next year pretty much standing still in real terms to reach -52.0%.
- in 1978 at -50.1% and over the next year heading to -53.1%.

I’m going to keep watching this comparison as I think it could be just starting to get interesting. Governments around the world are fast running out of borrowing capacity as Greece has aptly demonstrated. Closer to home the Bank of England has stated that more quantitative easing (QE) could be just around the corner. What will that do to inflation? The best growth that can be ‘created’ in the UK even with QE, bank bailouts and “cash for clunkers” is a miserly 0.1%. Finally, despite the big bonuses, I don’t see any evidence that the banking sector has repaired itself. I don’t see other developed economies being a whole lot better. Could we yet see that real -60% bear? History suggests there is still plenty of time for it to occur.

Assumptions include:
- Inflation data from the Bureau of Labor Statistics. January and February ‘10 inflation is extrapolated.
- Prices are month averages except February ‘10 which is the 12 February ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

US (S&P 500) Stock Market – February 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a Cyclically Adjusted Price / Average 10 Year Earnings (PE10 or CAPE) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller. Background information here.

Chart 1 plots the Shiller PE10. Key points this month are:

Shiller PE10 = 19.9 which is down from 20.6 last month. My UK Equities target asset allocation therefore increases from 18.6% to 18.8%. Additionally my International Equities target asset allocation increases from 13.3% to 13.4%.

Shiller PE10 Average (1881 to Present) = 16.4. This means we are currently still 21% higher than the long run average since 1881.

Shiller PE10 20 Percentile (1881 to Present) = 11.0

Shiller PE10 80 Percentile (1881 to Present) = 20.6. The Shiller PE10 has now fallen back through the 80 Percentile.

Shiller PE10 Correlation with Real (ie after inflation) S&P 500 Price = 0.78

Chart 2 further reinforces why I am using this method. While the R^2 is low there appears to be a trend suggesting that the return in the following year is dependent on the Shiller PE10 value. Using the trend line with a PE10 of 19.9 results in a 1 year expected real (after inflation) earnings projection of 5.2%.

Chart 3 plots Real (after inflation) Earnings and Real Dividends for the S&P 500. Real Dividends are still falling however they are still above their long term trend. Real Earnings have a roller coaster ride continually, particularly since about 1990. If the Standard and Poors forecast earnings are to be believed however we continue to be above the long term earnings trend and climbing.

Assumptions include:
- Q4 ’09 & Q1 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. January & February ‘10 inflation is extrapolated.
- January & February ‘10 dividends are estimated as December ‘09 dividend.
- Prices are month averages except February ‘10 which is the 11 February ’10 S&P 500 stock market at 1430.
- Historic data provided from Professor Shiller website.

As always DYOR.

A History of Severe Real S&P 500 Stock Bear Markets

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market 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, they then proceeded to lose in excess of 60% of their 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 what were these bear markets.

The first severe stock bear (marked in purple on the chart) market started with a new real high being reached in September 1906. This period incorporated the 1907 Bankers Panic which was caused by banks retracting market liquidity and depositors losing confidence in the banks. This occurred during an economic recession and there were a number of runs on banks and trust companies. Additionally many state and local banks were bankrupted. All sounds a bit familiar doesn’t it? So 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. This is obviously the well known period of the Great Depression. I won’t go into the history here as I’m sure it’s well known by all readers. What is interesting however is that the markets passed through -60% on a number of occasions. So from the high it took until January 1931 for the stock market to reach a real loss of 62.0% and then until June 1932 to reach 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. This occurred in January 1933, July 1934, April 1938, June 1940, February 1941 and was back at -73.1% in May 1942. That’s a period of 12 years and 8 months. Even 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. This period incorporated the stock market crash of 1973 to 1974 which came after the collapse of the Bretton Woods system and also incorporated the 1973 Oil Crisis. So from the 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.

So that brings me to the last line on the chart marked in red which shows 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 were unable to break through -60% ‘only’ reaching -58.6% in March 2009. That is a period of only 8 years and 7 months. Even today we are still -38.1% which is a period of 9 years and 5 months which is a relatively short period of time compared with the bears shown above.

My question is once the governments of the world are forced to stop stimulating the economies through borrowing (for example a bond market strike) or quantitative easing (for example excessive inflation) could we yet see that real -60% bear? History suggests there is still plenty of time for it to occur.

Assumptions include:
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.
- Prices are month averages except January ‘10 which is the 11 January ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

Further Reasons Why I Use the Shiller PE10

Regular readers will know that to try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I use a cyclically adjusted Price / Average 10 Year Earnings (PE10) ratio for the S&P 500 to value the US stock market. The method used is that developed by Yale Professor Robert Shiller. My latest update is that for January ’10.

The first chart today shows the chart that I show each month which reinforces why I use this method. The R^2 value is low at 0.0566 and the correlation is also low at -0.15. That said however these values, along with a look at the trend line, suggests that some advantage may be able to be taken of the relationship. I must point out here how the x and y axes are calculated for this chart.

The x axis should not be an issue for any regular reader. It is simply the monthly PE10 ratio which is the real (ie inflation adjusted back to 1871) price of the S&P 500 divided by the real monthly average of the previous 10 years earnings. The y axis is the real price in 13 months time minus the real price in 1 months time plus the real dividend all divided by the real price in 1 months time. Hope that makes sense... It is also important to note that I then calculate these values every month to form the scatter chart that I show.

I have been thinking about the fact that I am only analysing the historical return on investment from the S&P 500 that can be expected for a period of 1 year. I am certainly not a 1 year investor and so I wondered what these charts would look like for 5 or even 10 year periods.
To do this easily I am going to switch from monthly data points to one data point for each year which I have chosen to be January for no other reason than it is the first month of the year. This is because before I can run the real return calculations I first have to calculate a total return for the S&P 500 going back to 1871 and this is easiest done with yearly data.

Now to the interesting bit. Firstly, as a comparison to the monthly chart above my second chart shows the 1 year real total return versus the PE10. Charts three and four then show the 5 and 10 year real total return versus the PE10. Examining the R^2 and correlations shows:
1 year, R^2 0.0462, correlation -0.21
5 year, R^2 0.1554, correlation -0.39
10 year, R^2 0.2725, correlation -0.52

This for me is really interesting. It suggests that the longer the period of time you hold the stocks or equities the more the Shiller PE10 becomes a useful measure for predicting future expected real returns. This reinforces why I am using the PE10 ratio as part of my retirement investing strategy.

As always some assumptions:
- Q1 ’09 & Q2 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.
- January ‘10 dividend is estimated as December ‘09 dividend.
- Prices are month averages except January ‘10 which is the 11 January ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

US (S&P 500) Stock Market – January 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted Price / Average 10 Year Earnings (PE10) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller. Background information here.

Chart 1 plots the Shiller PE10. Key points this month are:
- Shiller PE10 = 21.0 which is up from 20.6 last month. My UK Equities target asset allocation therefore drops from 18.3% to 18.1%. Additionally my International Equities target asset allocation drops from 13.1% to 12.9%.
- Shiller PE10 Average (1881 to Present) = 16.4
- Shiller PE10 20 Percentile (1881 to Present) = 11.0
- Shiller PE10 80 Percentile (1881 to Present) = 20.6. The Shiller PE10 has now passed through the 80 Percentile.
- Shiller PE10 Correlation with Real (ie after inflation) S&P 500 Price = 0.78

Chart 2 further reinforces why I am using this method. While the R^2 is low there appears to be a trend suggesting that the return in the following year is dependent on the Shiller PE10 value. Using the trend line with a PE10 of 21.0 results in a 1 year expected real (after inflation) earnings projection of 4.4%.

Chart 3 plots Real (after inflation) Earnings and Real Dividends for the S&P 500. Real Dividends are still falling however they are still above their long term trend. Real Earnings have a roller coaster ride continually, particularly since about 1990. If the Standard and Poors forecast earnings are to be believed however we continue to be above the long term earnings trend. These forecasts maybe aren’t so good though with the year getting off to a bad start – profits at Alcoa (the first to report for 2010) down and Chevron also announcing lower fourth quarter profits than forecast.

Assumptions include:
- Q1 ’09 & Q2 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.
- January ‘10 dividend is estimated as December ‘09 dividend.
- Prices are month averages except January ‘10 which is the 11 January ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

Methods to Calculate Historical Market Returns – Arithmetic Means versus Compound Annual Growth Rates

When I described previously how I was building my low charge investment portfolio and forecasting potential future retirement dates it turns out that in mathematics terms I have generally been using arithmetic means to calculate percentage returns from various data sets. That means I've taken the yearly percentage change for each entry of the dataset, summed these values and then divided by the number of items in the dataset.

It looks like this might be too bullish a method and instead I potentially should be using the compound annual growth rate (CAGR) which is the smoothed annualised gain. The formula is CAGR = (End Value/Start Value)^(1/number of years)-1.

Let me demonstrate with an example. At the end of year 0 your index is worth 100, by the end of year 1 your index has increased to 200 and then by the end of year 2 your index has decreased to 150. Using the arithmetic mean the mean annual return is (100% [year 1 gain] + -25% [year 2 loss])/2 = 37.5%. This can’t be correct as you don’t have 100 x 137.5% x 137.5% = 189 at the end of year 2. Now using the CAGR the return is (150/100)^(1/2)-1 = 22.5%. Checking this 100 x 122.5% x 122.5% = 150.

Let me now calculate a stock market example, the real (ie inflation adjusted) S&P 500 for the period January 1871 to January 2009. Using the arithmetic mean we get an average annual real price increase of 3.7% and an average annual real dividend of 4.5% for an average annual real return of 8.2%. Now using the CAGR (more complicated to calculate as I had to first calculate a real total return for the S&P 500) for an average real return of 6.7% which is significantly less than the 8.2% arithmetic mean calculation.

I'm now considering calculating real CAGR returns for my (S&P 500, ASX 200 and Gold) datasets and using these when projecting my retirement dates and amounts.

As always I would be very interested to hear others experience here.

You might also be interested in calculating portfolio year to date returns, annualised returns or multiple year returns.