Sand Spring Advisors LLC

From 8 to 48: The S&P P/E

January 6, 2002

by, Barclay T. Leib

Some have criticized Sand Spring for its tentative unwillingness to get aboard the "massive" rally that has transpired since September 21, 2001.

We did, of course, anticipate an autumn market low of some sort, and correctly forecast that the the Nasdaq Composite and S&P 500 would both make lows within two respective "Fibonacci target zones" that were very close to the actual September 21st lows. But we will be the first to admit: We never "got aboard" the recent froth, and have been prematurely bearish of late.

Looking back, we started to lose our road-map when the September 21st low failed to match our anticipated October 11th cycle date. It was as if the events of the World Trade Center bombing somehow succeded in speeding up the natural rhythm of time, and it left us agog and confused in mid-October when prices were already rallying swiftly.

We then became further agog when, over a short period of time, several further events occured: General Motors beat the Federal Reserve to adopting a Japanese zero-interest rate policy; the Treasury attempted to manipulate the level of long-term interest rates lower by announcing the curtailment of 30-year Treasury bond issuance; and a mere day after that second event, the government miraculously announced that the Microsoft anti-trust case was "solved."

Indeed, together with the issuance of more "created credit" from the Fed than has ever transpired in so short a period of time, it would appear that the Bush administration pulled out almost every tool imaginable to set the markets back into a euphoric mode. This recently led Mitsui Bank's metals analyst Andy Smith to quip: "Rumours that Oliver Stone has bought the rights to this 'plot' may have some foundation."

But yet, we do not regret being prudent then, and we will not change our general vision now. You see, one glance at the chart below of the S&P 500 long-term price-earnings ratio will tell you that the underlying fundamentals of the recent rally truly stink. Quite simply stated, since February 2000, earnings have fallen faster than stock prices have net fallen, making it perhaps equally crazy to buy stocks on the current rally as it was to buy them at the NASDAQ peak in early 2000. Looking even further back in time, and in comparison to a modest 8 P/E that existed for the S&P 500 at the outset of the 1982 bull market, 2002 started with the S&P 500 P/E ratio at the extremely high level of 48.4! While the chart below clips off a short period of time during the 1930's Depression when a complete dearth of earnings sent the S&P 500 P/E ratio to above 100, rest assured, there is no compelling "value" to be found in the S&P 500 now.

Smoke and mirrors and tons of money from the Fed can work for awhile to keep consumer confidence artificially high, but this picture is a scary one. It tells us at Sand Spring that over time, a bear market hasn't even truly started. People want to believe that after two bad years for the market, the next one will surely be good. But are they basing this on fundamentals or simply hope and faith?

The people at Elliott Wave International recently pointed to an interesting newspaper quote:

"Americans are invested too deeply in Wall Street to walk way." -- USA Today
In other words, they can't admit that anything has changed. And they certainly don't want anything to have changed.

From this the Elliott Wave Intl. group concludes:

"It is an optimism borne of desperation, which is the deadliest form there is."
-- Well said!

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