Investors fear the worst, and may not snap out of their funk until prices touch rock bottom. So stocks could shed another 15 to 30 per cent. But when the world economy eventually recovers, shareholders will kick themselves for not taking advantage of this year's cheap prices.
Fundamental value benchmarks may count for little with markets in full, panicky, retreat. But the MSCI index of U.S. shares trades on a forward price-earnings ratio of 11, according to Thomson Reuters' Datastream. In October, 2008, the earnings multiple for this group dropped to 9.5, its lowest in recent history. If investors mark shares down to a similar level, U.S. shares will shed 15 per cent. The message from Europe is just slightly better, with a potential fall of 13 per cent.
It could be worse still, of course, if corporate earnings crack. At 20 per cent below current forecasts, they would be as bad as is credible: the gloomy IMF outlook tables on growth of at least 1 per cent in developed economies in 2012 and six times that in the emerging world. But if earnings do fall 20 per cent, and shareholders can stomach no more than a rock-bottom P/E ratio, stocks on both sides of the Atlantic could fall 30 per cent from here.
Optimists could draw different conclusions, of course. They would consider that these are halcyon days for the long-term equity investor. If corporate earnings meet current expectations, and P/E ratios drift back to recent averages, the U.S. index would rise 18 per cent. European shares – hit harder in recent months thanks to their proximity to the euro zone's sovereign debt crisis – could bounce 34 per cent.
Sure, the gyrations are alarming and the economic outlook is forbidding. There are no guarantees; and it pays to be selective – especially when it comes to banks. But patient, sanguine, investors could still harvest juicy fruits.