After about forty years of banking and investing, I retired in 2001. But since I don’t play golf, I soon found retirement very boring. So I decided to return to the world of investments after ten months. However, those ten months were not a complete waste of time, as I spent them trying to use my forty years of investment experience to gain perspective on the most recent stock market “bubble” and subsequent “crash.”

There were several people who saw the stock market crash coming, but had different ideas about when it would happen. Those who were too early had to suffer the ridicule of their peers. It was difficult to take a stand when so many proclaimed that we were in a “new era” of investing and that the old rules no longer applied. From early 1998 to the market high of March 2000, among Wall Street analysts’ 8,000 stock recommendations, only 29 recommended
“sell.”

I am on record calling for a cautious approach to investing two years before the “Crash of 2000.” In an internal investment newsletter dated April 1998, I have a photo of the “Titanic” with the caption: “Does anyone see any icebergs?”

When I returned to my job in 2002, I happened to look at the chart on the back page of Value Line, which showed that the stock market had coincidentally peaked in April 1998, the same date as my “Titanic!” “! The Value Line Composite Index peaked at 508.39 on April 21, 1998 and has been lower SINCE NOW. But on the first page of the same issue, the market high date was “5-22-01”! When I contacted Value Line about this discrepancy, I was surprised to learn that they had changed their method of calculating the “market top” index from “geometric” to “arithmetic.” They said they would change the name of the “Composite” Value Line Index to the “Geometric” Value Line Index, as that is how it has been calculated over the years. Value Line currently shows a recent market low on 9-10-02 and the most recent market high, based on this new “arithmetic” index, on 5-4-04, ANOTHER ALL TIME HIGH! If they had stuck to the original “geometric” index, the all-time high would still be April 21, 1998!

Later that year, I was pleasantly surprised to read in “Barron’s” an interview with Ned Davis of Ned Davis Research who said that his indicators had recaptured the beginnings of the bear market in April 1998, the same date as my “Titanic.” Newsletter! So, my instincts were correct! I think we are in a “secular” recession that started in April 1998 and the “Bubble of 2000” was a market rally in what was already a long-term bear market.

Shortly after I returned to my job in 2002, another event occurred. One day I noticed that, in their “Market Lab”, “Barron’s” had inexplicably changed the P/E ratio of the S&P 500 to 28.57 from 40.03 the previous week. This was due to a change in “operating” earnings of $39.28 from “net” or “reported” earnings of $28.31 the previous week. Others and I wrote to “Barron’s Mailbag” to complain about this change and disagree with it, as these new P/E ratios were not comparable to historical P/E ratios. “Barron apparently accepted our arguments and, approximately two months later, reverted to using “reported” earnings instead of “operating” earnings and revised the S&P 500 data to show a P/E ratio of 45.09 compared to with the previous week of 29.64.

But a similar problem occurred the next day at a sister publication to “Barron’s.” On April 9, 2002, “The Wall Street Journal” came out with a new format that included, for the first time, charts and data from the Nasdaq Composite, S&P 500 Index, and Russell 2000, in addition to its own three Dow Jones indices. . The P/E ratio for the S&P 500 was given as 26, instead of the 45.09 now found at “Barron’s.” I wrote to the WSJ and after much back and forth correspondence they finally accepted my argument and on July 29, 2002 they changed the P/E Ratio for the S&P 500 from 19 to 30. I had given them examples showing how some financial writers had inadvertently confused “apples” with “oranges” when comparing its P/E of 19, based on “operating” earnings, to the long-term average P/E of 16, based on “reported” earnings.

Because I started being cautious about investing as early as April 1998, thinking the price/earnings ratio for the stock market was dangerously high, I was not personally hurt by the “Crash of 2000” and tried to make it my clients less aggressive and more liquid positions in their investment portfolios. But the pressures to agree with the market were tremendous!

Price/earnings ratios do not allow us to “time the market”. But comparing them to past historical performance lets us know when a stock market is high and vulnerable to an eventual correction, even though others around us may have lost their way. High P/Es alert us to the need for caution and a conservative approach to our investment decisions, such as a renewed emphasis on dividends. Very high P/Es generally indicate that a long-term bear market may occur for a very long period of time. Apparently, we are now in a long-term bear market. But to determine whether the market is up, we need to keep an eye on the data being reported to us by members of the financial press, so we can compare “apples” to “apples.” When financial information appears to be incorrect, we as financial analysts owe it to the investment community to question that information. That is what I have concluded from my personal “odyssey” in the world of investments.

After three years in which the DJIA and S&P 500 closed below their previous year-end figures, the market finally closed higher in late 2003. But the P/E ratio remains high for both indices.

Does anyone see any icebergs?