Most of the time, common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble ... to give way to hope, fear and greed.I remain firmly committed to the notion that we are in The Land of Chicken Littles and that the world equity markets are now tracing an important bottom. For the second consecutive week on CNBC, I reiterated my more optimistic message. Last night on CNBC's "Fast Money," Dylan Ratigan started my segment with a quote from The Intelligent Investor's Benjamin Graham that underscored a still expensive market. Essentially, Yale's Dr. Robert Shiller made the case that applying Graham's view that a 10-year period of smoothed corporate profits took out distortions and concluded that the S&P 500 index trades at 13 times compared to a multiple under 10 times at the bottom of the last three recessions, suggesting that U.S. stocks were about 25% overvalued. My response was that the investment mosaic has grown a lot more complicated and a 10-year period provides far too few empirical data points, and it is too linear to use only one model, as Shiller suggests. I prefer to look at multiple models. As it relates to Graham's observation, I would prefer to look at normalized earnings (12% ROE) on the S&P's book value of $560 -- or EPS of about $67 a share. Over a lengthier and more statistically significant period -- seven decades -- stocks tended to trade at 15 times normalized S&P profits (S&P equivalent of 1005) and bottomed at between 11.5 times and 12.0 times (S&P equivalent of 787). We are now at only 685 of the S&P, or at a 10 times multiple, so rather than being overvalued -- as Benjamin Graham/Robert Shiller might opine -- stocks have overshot the downside valuation that has historically provided support and now appear undervalued.
-- Benjamin Graham
Kass: Market Bottom Call (Part Deux)
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