More about Short Term Price Fluctuations

I have constructed more tables that tell us about short-term price fluctuations.

New Groupings

I extracted monthly (nominal) prices from January 1921 through December 1980 and P/E10 from Professor Robert Shiller’s database. I determined the lowest price within the following 1, 2 and 5 years (12, 24 and 60 months) and divided it by the original price. Similarly, I determined the highest price within the following 1, 2 and 5 years. Again, I expressed it as a ratio relative to the original price.

Once again, I sorted the data into deciles. Each decile contains 72 of the 720 months of data. This time I sorted each set of data according to outcomes (i.e., the minimum and maximum price ratios within the following 1, 2 or 5 years). Then I counted the number months within each decile for which P/E10 was below 10, between 10 and 15, between 15 and 20, between 20 and 25 and above 25.

Each sorting process was totally independent of the others.

Price Dips

The following tables show the worst price dips. These show the P/E10 distribution for the 360 (out of 720) worst monthly prices of the S&P500 during the following 1, 2 and 5 years throughout 1921-1980.

WORST 360 MONTHS OUT OF 60 YEARS: lowest prices in the following year

Pmin(1yr)/P..<10..10to15..15to20..20to25..>25

0.33 to 0.78 6 15 28 18 5
0.78 to 0.85 1 20 27 18 6
0.85 to 0.90 13 31 18 8 2
0.90 to 0.93 13 37 16 6 0
0.93 to 0.96 16 28 20 8 0
For the remaining months, 89 had P/E10 below 10. For 141 months, P/E10 was between 10 and 15. For 84 months, P/E10 was between 15 and 20. For 46 months, P/E10 was between 20 and 25. In no month was P/E10 above 25.

WORST 360 MONTHS OUT OF 60 YEARS: lowest prices in the following two years

Pmin(2yr)/P..<10..10to15..15to20..20to25..>25

0.22 to 0.67 4 4 35 17 12
0.67 to 0.79 2 27 26 16 1
0.79 to 0.86 5 27 23 17 0
0.86 to 0.90 12 32 18 10 0
0.90 to 0.93 13 33 17 9 0
For the remaining months, 102 had P/E10 below 10. For 149 months, P/E10 was between 10 and 15. For 74 months, P/E10 was between 15 and 20. For 35 months, P/E10 was between 20 and 25. In no month was P/E10 above 25.

WORST 360 MONTHS OUT OF 60 YEARS: lowest prices in the following five years

Pmin(5yr)/P..<10..10to15..15to20..20to25..>25

0.15 to 0.58 2 4 29 24 13
0.58 to 0.70 2 15 55 0 0
0.71 to 0.79 2 32 19 19 0
0.79 to 0.85 5 26 12 29 0
0.86 to 0.90 12 34 14 12 0
For the remaining months, 115 had P/E10 below 10. For 161 months, P/E10 was between 10 and 15. For 64 months, P/E10 was between 15 and 20. For 20 months, P/E10 was between 20 and 25. In no month was P/E10 above 25.

Lessons about Price Dips

Bargain prices (P/E10 less than 10) protect your downside throughout all time frames. Attractive, but reasonable prices (with P/E10 between 10 and 15), generally limit the worst case outcomes to two years. P/E10 levels between 15 and 20 do not protect you against deep dips. In fact, once P/E10 rises above 15, you should prepare yourself for 50% price drops as a matter of routine.

Price Increases

The following tables show the best price increases. These show the P/E10 distribution for the 360 (out of 720) best monthly prices of the S&P500 during the following 1, 2 and 5 years throughout 1921-1980.

Each decile consists of 72 months.

BEST 360 MONTHS OUT OF 60 YEARS: highest prices in the following year

Pmax(1yr)/P..<10..10to15..15to20..20to25..>25

1.12 to 1.16 16 29 17 10 0
1.16 to 1.20 22 24 18 7 1
1.20 to 1.26 23 23 20 1 5
1.26 to 1.33 18 35 17 2 0
1.34 to 2.24 25 33 7 5 2
For the remaining months, 34 had P/E10 below 10. For 128 months, P/E10 was between 10 and 15. For 114 months, P/E10 was between 15 and 20. For 79 months, P/E10 was between 20 and 25. In 5 months, P/E10 was above 25.

BEST 360 MONTHS OUT OF 60 YEARS: highest prices in the following two years

Pmax(2yr)/P..<10..10to15..15to20..20to25..>25

1.22 to 1.28 13 24 20 11 4
1.28 to 1.34 22 25 25 0 0
1.34 to 1.43 30 31 9 0 2
1.43 to 1.56 31 34 5 2 0
1.57 to 2.37 14 42 11 5 0
For the remaining months, 28 had P/E10 below 10. For 116 months, P/E10 was between 10 and 15. For 123 months, P/E10 was between 15 and 20. For 86 months, P/E10 was between 20 and 25. In 7 months, P/E10 was above 25.

BEST 360 MONTHS OUT OF 60 YEARS: highest prices in the following five years

Pmax(5yr)/P..<10..10to15..15to20..20to25..>25

1.55 to 1.63 14 36 19 3 0
1.63 to 1.77 23 34 13 2 0
1.77 to 1.98 27 37 8 0 0
1.98 to 2.20 19 50 3 0 0
2.20 to 3.80 43 29 0 0 0
For the remaining months, 12 had P/E10 below 10. For 86 months, P/E10 was between 10 and 15. For 150 months, P/E10 was between 15 and 20. For 99 months, P/E10 was between 20 and 25. In 13 months, P/E10 was above 25.

Lessons about Price Increases

The most dramatic price increases occur when P/E10 is attractive, below 15. This is true at years 1, 2 and 5. The upside is limited when P/E10 is between 15 and 20. It is almost nonexistent when P/E10 exceeds 20.

Conclusions

Remember that today’s P/E10 is close to 27.

Keep in mind that these data are descriptive of what has happened. They do not come with a guarantee. But they do form a reasonable starting point for determining what is likely to happen in the future.

I have included the P/E10 distribution of the conditions that are not in the tables to help fill in other parts of the picture. For example, there were only 13 months between January 1921 and December 1980 with P/E10 above 25. Do not take any comfort because “only” 13 months fell to a lower price ratio between 0.15 and 0.58 over the next five years. It happened every time that P/E10 exceeded 25.

P/E10 ratios of 15 to 20 define a region of uncertainty. Whenever P/E10 is below 15 or above 20, you can develop meaningful rules of thumb.

Have fun.

John Walter Russell
November 7, 2006