From around 1999 to 2001, I dabbled in a little day trading. I wasn't make many trades a day, but I probably averaged somewhere between 50 and 100 a year. It was the complete opposite of the buy and hold strategy that I largely hold today. During that era, I learned a lot about technical analysis of the stock market. With a tiny amount of pride, I can say that I forgotten most of it. Hopefully that space in my head can be used with something a little more worthwhile.
A few weeks ago, I wrote an article New Nonsensical Stock Trading Idea: Someone Else Paid A Lot More For It, where the commenter, correctly, called me out for marketing timing. I think the discussion that took place was one of the most interesting in the 6 years I've been writing Lazy Man and Money and highly recommend reading it. Today, I'd like to focus on just one small part of that conversation.
In the course of the discussion, I had made the case that I think with the Dow Jones Industrial Average (DJIA) up around 13,000 stocks looked expensive. My rational was that except for a short time in 2007 the DJIA hadn't rarely been above 13,000 and it barely crossed 14,000 before dropping and then getting hit by the banking collapse in late 2008. Clearly once again, the DJIA is getting too expensive, right?
I love to be proven wrong as it gives me an opportunity to learn. This is a case where I learned a lot.
Where did I go wrong? I looked at absolute numbers, like Dow 13,000, and not the math behind them.
The commenter, Jim, had pointed out that the S&P 500 was actually very cheap when you look at its price relative to its earnings. Jim showed the graph:
where it looks like the price-to-earnings ratio is around 13, which is historically fairly low indicating that stocks in general are not expensive. However, if you were looking for a cheap time to buy into stocks, like say the beginning of 2009, when the Dow had dropped to around the 7,000 range, this chart wouldn't be very helpful.
It's at that point that I started to look into this in a little more detail. I found that there is something called the Shiller P/E (yes same Robert Schiller mentioned here: Buying a Vacation/Retirement Home (Part 5)) that is does seem to spike during these blips of historically cheap times to buy. Here's a telling chart from Multpl.com:
That chart might be a little small, but hopefully you can make the peaks at the 1991, 2001, and 2008 market drops.
It's worth noting that the chart isn't currently screaming that it's time to buy like on the other big dips.
Using the two charts, my admitted amateur opinion is that stocks are fairy cheap, but that they aren't screaming deals that they've been a few times in the last 20+ years.
The bigger lesson here is to not look at absolute numbers. It was something that I had known for a long time, but had simply forgotten. It's a strong reminder to me that every now and again it is wise to go back to the basics.
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