Home > Library > Stable Times > Volume 5, Issue 4  

Market Expert Sees Glimmer of Hope for Stock Market

It's awfully hard to make a bullish case for the stock market right now, with stock prices tumbling for most of the past 18 months and the economy seemingly on the verge of a recession. But Peter Richiutti, Assistant Dean at Tulane University's A.B. Freeman School of Business, isn't above trying.

Speaking at the SVIA Forum, Richiutti said that while the market appears "pretty fairly priced, maybe a little underpriced," he added that by one important measure it is as cheap as its been in his 23 years in the investment business. (Prior to joining academia, Richiutti managed a $3 billion investment portfolio for the state of Louisiana as its Assistant Treasurer and Chief Investment Officer. Before that, he had a successful career on Wall Street.)

The measure to which Richiutti referred is the stock market's earnings yield relative to the yield on the 10-year Treasury note. Over time, he explained, the stock market has proved to be fairly valued when the inverse of its price-to-earnings ratio, or earnings yield, is about equal to the yield on the bellwether U.S. Treasury long bond. When the earnings yield is significantly above the yield on the long bond, stocks have turned out to be underpriced.

At recent levels, Richiutti said, the price/earnings ratio for the stock market, as represented by Wall Street earnings estimates for the companies in the Value Line Index, stood at 16.1. Dividing that ratio into the number one to get the market's earnings yield produces a result of 6.2%. By comparison, the yield on the bellwether 10-year US Treasury note recently stood at 4.54%. With that kind of return on bonds, Richiutti's analysis indicates, the stock market could support a price-to-earning ratio of 22, or roughly 37% higher than its current level.

To be sure, Richiutti noted, many securities analysts may still be revising their earnings estimates downward, which would raise the market's price-to-earnings ratio and make it appear more expensive—or less cheap—than it currently looks.

In the meantime, Richiutti also noted that while the terrorists' attacks of September 11 may hasten the U.S. economy's slide into a recession, economic incentives put in place by the government since then could help the nation pull out of that recession faster than it would have otherwise.

Finally, Richiutti reminded his audience that since 1956 the average bear market only lasts about 12 months. By that measure, the current market downturn could be over by March 2002, since the major stock market indices hit bear territory in March 2001. Before that can happen, though, Richiutti said the bear market will have to enter its third and final phase in which fear of deeper stock market losses and a recession become so worrisome that investors give up on stocks, setting the stage for a recovery.

Read Next: Rise of "Instividual" Market Reinforces Need for Advice