Stocks: cheaper, but still not cheap

Mish makes an excellent point:

Think the stock market is cheap? Let’s do the math. The S&P closed [2008] at 910. If those earnings estimates hold, the effective PE is 21.53. The historical average PE is about 15. At a PE of 15 the S&P would drop to 634. That is a huge drop of 30% from today’s closing price.

What happens if the stock market over shoots as it typically does in bear markets. Assume a PE of 12. At 12, one might expect to see the S&P at 507. That would be an even bigger decline of 44% from here.

Paying attention to those historical norms is important. The historical norm for the ratio of home mortgages to incomes was about 3 to 1. During the real estate gold rush that ratio got completely out of control – hitting 5 or 6 to 1 in some areas if you compare median home prices to median incomes. That wasn’t sustainable and now real estate prices in those areas are coming back down in a hurry.