Wednesday, July 12, 2000
To the Editor:
Your 7/10/2000 article, "First-Half Blues: Better times may lie ahead" by Jacqueline Doherty, illustrates why technical analysis gets such a bad rap in the popular financial press. Although Doherty is correct in her observation, as provided by Ned Davis, that markets in the past have tended to rebound in the 6 months following a down first half, a closer look at the numbers reveals this time may be different.
Whenever a market corrects or declines, one must ask from what level. Clearly, when the NASDAQ soared from 3,000 to 5,000 in a matter of months, a 30% sell-off was less meaningful (and perhaps less predictive of a future surge) than a 30% sell-off from a much lower starting level. Rather than getting lost in the arcane world of price retracements and Fibonacci series, there is a very simple way of answering the question, how high is high: how many dollars are investors willing to pay for a dollar of company earnings? Turned on its head, what is the earnings yield, or 12 month trailing earnings for the S&P500 divided by the S&P500 price level? (As of the end of June, 2000, it was 3.50% for the S&P500.)
This exercise is helpful because it helps us compare the S&P500 through history and keeps us from getting too distracted by the nominal rise in the index in recent years. It also reminds us that the market by this measure is indeed at breathtaking height. Therefore, Doherty's conclusion that the market is probably destined to head higher over the next 6 months is less compelling.
Let's do the numbers. As of the end of June, 2000, the S&P500 had fallen 1% according to your table over the prior 6 months. Its closing value in June, 2000, gave it an earnings yield of only 3.50%. Only 2 other Junes since 1980 had lower (more highly valued) earnings yields. It is sobering to note that the strongest 6 month advance following a decline occurred in 1982, when the S&P500 had a mid-year earnings yield of 12.77%. Sure, a down market is statistically likely to bounce back, but down is a relative term. A market trading at 30 times earnings simply does not have the same room for earnings expansion and therefore upside potential as one trading at less than 10 times earnings.
Some simple stats help make the point. Of the 5 down post-1980 first halfs for which we have follow-up data (we don't know how this year will end):
- the average second half gain was 8.21% (v. 4.95% for the 15 times the market was up during the first half);
- when the earnings yield was over 10%, however, the market performed much better, returning 10.30% over the subsequent 6 months (4.20% better than Treasury bills) v. only 5.07% for those periods when the earnings yield was <>
However, if you had invested in the S&P500 even after it rose the first 6 months but still had a mid-year earnings yield over 10%, your return would have been a whopping 18.84% on average over the next 6 months, or 15.34% better than Treasury bills! Moral of the story: valuation does matter. If you have to choose between a market that is down relative to some arbitrary year-end price and one that is cheaply valued relative to earnings, valuation wins out hands-down.
In fact, one could argue that most of the "excess" return observed following 6 month down periods in the past was due not so much to the fact that the market had declined but that it had reached a period of very cheap valuation relative to earnings.
Finally, if you insist on using some arbitrary past price level as a gauge of the market's value today, why not use a longer period than 6 months; how about 3 years? If you do this, then a different picture emerges.
The market rose 64.3% over the 36 months prior to June, 2000. This is more than it rose over the 36 months prior to any of the 5 down first halfs since 1980, more by a long shot. The second greatest 36 month advance was 37.35% in June, 1981, after which the market subsequently lost 6.60% over the next 6 month period (in fact, this was the only losing 6 month period following a down prior 6 month period). The next 36 month returns in order of magnitude returned 6.76% and 3.38% (a paltry 1.31% above Treasury bills). It is interesting to note that the two lowest prior 36 month returns (of the 5 down first halfs) had the best subsequent 6 month returns (9.18% in June, 1984 and 28.31% in June, 1982).
So we maybe down for the year, but we are still way up for the prior 3 year period and in nosebleed valuation territory. Sure, the market may continue to rise, but if it does it's unlikely to have anything to do with the fact that it declined a little in the first half of this year.
Mark Vakkur, MD
Atlanta, Georgia
404 377-8684
404 321-6111 x 6008
Supporting Tables:
| If history holds true, investors can look forward to a rosy, though perhaps unspectacular, second half of 2000. | ||||||||
| Year | First Half | Second Half | Full Year | E yld Jun: | E yld Dec: | Prior 36 m: | 90 d T yld: | Second half - 90d/2: |
| 1980 | 5.84 | 18.84 | 25.77 | 12.99% | 10.92% | 13.69% | 7.00% | 15.34% |
| 1981 | -3.35 | -6.6 | -9.73 | 11.50% | 12.53% | 37.35% | 14.56% | -13.88% |
| 1982 | -10.56 | 28.31 | 14.76 | 12.77% | 8.99% | 6.51% | 12.11% | 22.26% |
| 1983 | 19.53 | -1.89 | 17.27 | 7.94% | 8.51% | 47.16% | 8.82% | -6.30% |
| 1984 | -7.12 | 9.18 | 1.4 | 10.01% | 9.95% | 16.74% | 9.94% | 4.21% |
| 1985 | 14.72 | 10.13 | 26.33 | 8.15% | 6.91% | 75.03% | 7.01% | 6.63% |
| 1986 | 18.72 | -3.46 | 14.62 | 5.80% | 5.98% | 49.21% | 6.21% | -6.57% |
| 1987 | 25.53 | -18.72 | 2.03 | 5.26% | 7.08% | 98.46% | 5.69% | -21.57% |
| 1988 | 10.69 | 1.54 | 12.4 | 7.54% | 8.56% | 42.56% | 6.50% | -1.71% |
| 1989 | 14.5 | 11.14 | 27.25 | 7.33% | 6.47% | 26.77% | 8.22% | 7.03% |
| 1990 | 1.31 | -7.76 | -6.56 | 6.18% | 6.46% | 17.77% | 7.74% | -11.63% |
| 1991 | 12.4 | 12.37 | 26.31 | 5.02% | 3.81% | 35.71% | 5.60% | 9.57% |
| 1992 | -2.15 | 6.76 | 4.46 | 4.29% | 4.38% | 28.35% | 3.70% | 4.91% |
| 1993 | 3.4 | 3.53 | 7.06 | 4.55% | 4.69% | 25.84% | 3.10% | 1.98% |
| 1994 | -4.76 | 3.38 | -1.54 | 5.91% | 6.66% | 19.70% | 4.14% | 1.31% |
| 1995 | 18.61 | 13.07 | 34.11 | 5.93% | 5.51% | 33.47% | 5.43% | 10.36% |
| 1996 | 8.88 | 10.45 | 20.26 | 5.42% | 5.23% | 48.85% | 5.03% | 7.94% |
| 1997 | 19.49 | 9.64 | 31.01 | 4.43% | 4.09% | 99.23% | 5.05% | 7.12% |
| 1998 | 16.84 | 8.41 | 26.67 | 3.44% | 3.07% | 108.14% | 4.97% | 5.93% |
| 1999 | 11.67 | 7.03 | 19.53 | 2.99% | 3.28% | 104.68% | 4.67% | 4.70% |
| 2000 | -1 | N/A | N/A | 3.50% | 64.34% | 5.60% | ||
| Year | First Half | Second Half | Full Year | E yld Jun: | E yld Dec: | Prior 36 m: | 90 d T yld: | Second half - 90d/2: |
| 1982 | -10.56 | 28.31 | 14.76 | 12.77% | 8.99% | 6.51% | 12.11% | 22.26% |
| 1984 | -7.12 | 9.18 | 1.40 | 10.01% | 9.95% | 16.74% | 9.94% | 4.21% |
| 1994 | -4.76 | 3.38 | -1.54 | 5.91% | 6.66% | 19.70% | 4.14% | 1.31% |
| 1981 | -3.35 | -6.60 | -9.73 | 11.50% | 12.53% | 37.35% | 14.56% | -13.88% |
| 1992 | -2.15 | 6.76 | 4.46 | 4.29% | 4.38% | 28.35% | 3.70% | 4.91% |
| 1990 | 1.31 | -7.76 | -6.56 | 6.18% | 6.46% | 17.77% | 7.74% | -11.63% |
| 1993 | 3.40 | 3.53 | 7.06 | 4.55% | 4.69% | 25.84% | 3.10% | 1.98% |
| 1980 | 5.84 | 18.84 | 25.77 | 12.99% | 10.92% | 13.69% | 7.00% | 15.34% |
| 1996 | 8.88 | 10.45 | 20.26 | 5.42% | 5.23% | 48.85% | 5.03% | 7.94% |
| 1988 | 10.69 | 1.54 | 12.40 | 7.54% | 8.56% | 42.56% | 6.50% | -1.71% |
| 1999 | 11.67 | 7.03 | 19.53 | 2.99% | 3.28% | 104.68% | 4.67% | 4.70% |
| 1991 | 12.40 | 12.37 | 26.31 | 5.02% | 3.81% | 35.71% | 5.60% | 9.57% |
| 1989 | 14.50 | 11.14 | 27.25 | 7.33% | 6.47% | 26.77% | 8.22% | 7.03% |
| 1985 | 14.72 | 10.13 | 26.33 | 8.15% | 6.91% | 75.03% | 7.01% | 6.63% |
| 1998 | 16.84 | 8.41 | 26.67 | 3.44% | 3.07% | 108.14% | 4.97% | 5.93% |
| 1995 | 18.61 | 13.07 | 34.11 | 5.93% | 5.51% | 33.47% | 5.43% | 10.36% |
| 1986 | 18.72 | -3.46 | 14.62 | 5.80% | 5.98% | 49.21% | 6.21% | -6.57% |
| 1997 | 19.49 | 9.64 | 31.01 | 4.43% | 4.09% | 99.23% | 5.05% | 7.12% |
| 1983 | 19.53 | -1.89 | 17.27 | 7.94% | 8.51% | 47.16% | 8.82% | -6.30% |
| 1987 | 25.53 | -18.72 | 2.03 | 5.26% | 7.08% | 98.46% | 5.69% | -21.57% |
| 2000 | -1.00 | N/A | N/A | 3.50% | 64.34% | 5.60% | ||
| Of the 5 down first halfs: | ||||||||
| Year | First Half | Second Half | Full Year | E yld Jun: | E yld Dec: | Prior 36 m: | 90 d T yld: | Second half - 90d/2: |
| 1982 | -10.56 | 28.31 | 14.76 | 12.77% | 8.99% | 6.51% | 12.11% | 22.26% |
| 1984 | -7.12 | 9.18 | 1.40 | 10.01% | 9.95% | 16.74% | 9.94% | 4.21% |
| 1994 | -4.76 | 3.38 | -1.54 | 5.91% | 6.66% | 19.70% | 4.14% | 1.31% |
| 1981 | -3.35 | -6.60 | -9.73 | 11.50% | 12.53% | 37.35% | 14.56% | -13.88% |
| 1992 | -2.15 | 6.76 | 4.46 | 4.29% | 4.38% | 28.35% | 3.70% | 4.91% |
| Average: | 8.21 | 1.87 | 8.90% | 8.50% | 21.73% | 8.89% | 3.76% | |
| When Eyld > 10%: | 10.30 | 2.14 | 11.43% | 10.49% | 20.20% | 12.20% | 4.20% | |
| When Eyld <> | 5.07 | 1.46 | 5.10% | 5.52% | 24.03% | 3.92% | 3.11% | |
| When 36m <> | 13.62 | 4.87 | 9.56% | 8.53% | 14.32% | 8.73% | 9.26% | |
| 36m > 20%: | 0.08 | -2.64 | 7.89% | 8.46% | 32.85% | 9.13% | -4.49% | |
| Year | First Half | Second Half | Full Year | E yld Jun: | E yld Dec: | Prior 36 m: | 90 d T yld: | Second half - 90d/2: |
| 1990 | 1.31 | -7.76 | -6.56 | 6.18% | 6.46% | 17.77% | 7.74% | -11.63% |
| 1993 | 3.40 | 3.53 | 7.06 | 4.55% | 4.69% | 25.84% | 3.10% | 1.98% |
| 1980 | 5.84 | 18.84 | 25.77 | 12.99% | 10.92% | 13.69% | 7.00% | 15.34% |
| 1996 | 8.88 | 10.45 | 20.26 | 5.42% | 5.23% | 48.85% | 5.03% | 7.94% |
| 1988 | 10.69 | 1.54 | 12.40 | 7.54% | 8.56% | 42.56% | 6.50% | -1.71% |
| 1999 | 11.67 | 7.03 | 19.53 | 2.99% | 3.28% | 104.68% | 4.67% | 4.70% |
| 1991 | 12.40 | 12.37 | 26.31 | 5.02% | 3.81% | 35.71% | 5.60% | 9.57% |
| 1989 | 14.50 | 11.14 | 27.25 | 7.33% | 6.47% | 26.77% | 8.22% | 7.03% |
| 1985 | 14.72 | 10.13 | 26.33 | 8.15% | 6.91% | 75.03% | 7.01% | 6.63% |
| 1998 | 16.84 | 8.41 | 26.67 | 3.44% | 3.07% | 108.14% | 4.97% | 5.93% |
| 1995 | 18.61 | 13.07 | 34.11 | 5.93% | 5.51% | 33.47% | 5.43% | 10.36% |
| 1986 | 18.72 | -3.46 | 14.62 | 5.80% | 5.98% | 49.21% | 6.21% | -6.57% |
| 1997 | 19.49 | 9.64 | 31.01 | 4.43% | 4.09% | 99.23% | 5.05% | 7.12% |
| 1983 | 19.53 | -1.89 | 17.27 | 7.94% | 8.51% | 47.16% | 8.82% | -6.30% |
| 1987 | 25.53 | -18.72 | 2.03 | 5.26% | 7.08% | 98.46% | 5.69% | -21.57% |
| Average: | 4.95 | 18.94 | 6.20% | 6.04% | 55.10% | 6.07% | 1.92% | |
| When Eyld > 10%: | 18.84 | 25.77 | 12.99% | 10.92% | 13.69% | 7.00% | 15.34% | |
| When Eyld <> | 3.96 | 18.45 | 5.71% | 5.69% | 58.06% | 6.00% | 0.96% | |
| When 36m <> | 5.54 | 9.61 | 9.58% | 8.69% | 15.73% | 7.37% | 1.86% | |
| 36m > 20%: | 4.86 | 20.37 | 5.68% | 5.63% | 61.16% | 5.87% | 1.93% | |
| 36m > 60%: | 3.30 | 21.11 | 4.85% | 4.89% | 97.11% | 5.48% | 0.56% | |
| 3.30 | 21.11 | 4.85% | 4.89% | 97.11% | 5.48% | 0.56% | ||
| Of top 10 first half gainers: | ||||||||
| 4.77 | 22.51 | 5.63% | 5.47% | 67.79% | 6.17% | 1.69% | ||
| Of bottom 9 first half losers: | ||||||||
| 7.34 | 6.21 | 8.18% | 7.76% | 23.87% | 7.48% | 3.60% | ||
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