This has been a challenging year for both professional and everyday investors. The benchmark S&P 500 produced its worst return in over forty years in the first half of the year. Since hitting a new all-time high in November, the growth stock-driven index has plummeted as much as 34%.
Both the S&P 500 and the Nasdaq have fallen into bear market territory. Many investors are wondering where the market will bottom given the heightened volatility of bear markets.
We have no idea. Everyone would use the indicator if it was 100% accurate. Two valuation indicators have called bear market bottoms before.
The image came from the same source as the one above.
The S&P 500's P/E ratio is the first valuation indicator that has called bear market bottoms in the past. A forward P/E ratio divides the price of a security into Wall Street's consensus forecast earnings for the upcoming fiscal year, as opposed to a traditional P/E ratio which looks at trailing earnings over a 12 month period.
The S&P 500 has had a number of large declines, including the dot-com bubble, financial crisis, and the coronaviruses crash. The S&P 500's forward P/E ratio has been between 13 and 14 for the majority of the time.
The S&P 500 had a forward P/E of 15.9. This is a cheap forward-year valuation based on where the S&P 500 has been this century. In order for the S&P 500 to hit a bear market bottom, the forward P/E would need to fall by another 11.95%. We're talking about a bottom in the range of 3,098.65 to 3,337.03 on the upside.
The P/E ratio of the S&P 500 is subject to change. With the U.S. economy delivering back-to-back quarters of declining GDP, it's possible corporate earnings will need to be revised lower.
The data is from the S&P 500 Shiller CAPE ratio.
There is a perfect record of calling bear markets for the other valuation indicator of interest. The S&P 500's Shiller P/E ratio is known as the CAPE ratio. The Shiller P/E looks at inflation-adjusted earnings over the last decade.
There have only been five instances where the Shiller P/E ratio has exceeded 30. The result was a bear market because the Shiller P/E stayed above 30 in all but one instance. This is how the previous five instances have ended.
The stock market has bottomed out with a Shiller P/E of around 22 over the last 25 years. The Shiller P/E is currently sitting at 28.13. It would mean a bottom for the S&P 500 at 2,959.
The S&P 500's bear market bottom could be found between a range of 2,959.12 and 3,337.03.
The image came from the same source as the one above.
There is more to this story. While bear markets can be scary and test the resolve of investors, history shows that buying during these large downturns is a genius move.
Crestmont Research releases data every year that shows the 20-year rolling total returns of the S&P 500. The data shows an annual average total return over the course of 20 years. Every year from 1939 to 1959 would be included in the rolling 20-year returns.
If an investor bought an S&P 500 tracking index at any point in the last century and held it for 20 years, they generated a positive total return. The average total return for the 103 years was at least 10.9%. During these two decades, investors doubled their money every seven years.
Only a few end years produced an average total return of less than 5%. The investors walked away with a positive return.
Buying and holding equities for extended periods of time is a trusted moneymaking formula no matter what the stock market does.
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