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Tuesday, July 31, 2007

Cheapest Stocks in 16 Years Draw Investors Amid Rout

What a great headline... until you read the article.

" Investors are preparing to snap up shares of telephone, health-care and computer companies after last week's $2.1 trillion global stock market rout left U.S. equities the cheapest in 16 years. "

Cheapest in 16 years? Easy money right? But wait, cheapest by what measure and why?

" The benchmark for American equity is valued at 15.5 times estimated profit, the lowest since January 1991, according to data compiled by Bloomberg. "

So its PE ratios we're talking about. More specifically forward PE ratios. Stocks are cheap based on current estimates of future earning's when compared to current prices. What if the 'E' part of the PE ratio is a little optimistic? These estimates are for growth far above trend and were made after record earnings growth over the last few years. A reversion to the mean alone would suddenly make a cheap market quite expensive. An actual recession, perhaps sparked by the capitulation of an over extended consumer, would really blow up this 'cheapest stocks' argument.

Where are the risks? With the largest real-estate correction since the 1930's and credit markets all shook up, where are the risks? Which surprises are most likely? To the upside or to the downside?

Factor in the possibility of a lost war in Iraq and things don't look nearly that 'cheap'.

Source: Cheapest Stocks in 16 Years Draw Investors Amid Rout (Update5) (