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Tuesday, July 7, 2009

Earnings and PE Ratios Mean Equities Could Drop a Lot More

FN: The S&P 500 could drop down to as low as 315 if earning and PE ratios do what they did during the Great Depression.

"The moral of the story of course is that a PE ratio is pretty meaningless by itself. What matters is where earnings will be in the future. The best guide to that is simply mean reversion. Corporate profits tend to revert to about 6% of GDP. They recently peaked at almost twice that. If they bottom at half this average that would be a 75% fall just like in the Depression. If that happens we might expect the S&P to fall to at least a PE of 15. The S&P 500 earnings peaked about about 85 so a 75% decline would be 21 and a 15 PE would bring the index to a horrifying 315 a 65% decline from here."

Full post over at Certain Ruin, Earnings and PE Ratios in the Great Depression.