WHAT IS a Graveyard Market
A graveyard market is one in which bearish sentiment persists, causing existing investors to sell and new investors to stay on the sidelines. Existing investors do not want to acknowledge their large unrealized losses, and, as a result, they may not even look at their brokerage statements. At the same time, new investors remain fearful of future market declines and are reluctant to buy, even at lower prices. For both groups, the market appears dead, or in a zombie-like state.
BREAKING DOWN Graveyard Market
A graveyard market reflects huge declines in the market over many months, if not years. Risk aversion is the dominant theme, even though valuation multiples may be low by historical standards.
For example, the S&P 500 dropped by 56.8% over the course of 517 days during the bear market of 2007-2009. Current, forward and even 10-year, or CAPE stock multiples all fell precipitously, but buyers still remained reluctant until March of 2009. Even then, many who had money to invest refused to re-enter for quite some time.
Conversely, Black Monday, in 1987, is not a graveyard market even though it ranks among the very worst declines for a single trading day, in percentage terms. Unlike the graveyard market conditions in 2007-2009, the 1987 crash did not last very long.
Fairly short-lived market declines as measured by points also are not graveyard markets. For example, the Dow Jones Industrial Index posted a record decline as measured by index points in February 2018. This led to many negative news headlines, but not a graveyard market.
Some of the worst graveyard markets of all time include the market crash of 1929 that preceded the Great Depression, the Tech Bubble of 2000 and the aforementioned Great Recession of 2007-2009.
Gauging a Graveyard Market
There is no single tool for predicting a graveyard market, or when it may end. One useful gauge, however, is the CAPE ratio, developed by Yale economics professor Robert Shiller. It also is known as the Shiller P/E, or P/E 10 ratio. The CAPE ratio smooths fluctuations in market P/Es that are the result of boom and bust economic cycles.
For example, companies tend to have higher earnings during an economic boom. In turn, this inflates their prices and the market's overall value. The result is a low current price-to-earnings ratio that does not accurately reflect the market’s value.
Similarly, earnings tend to fall amid a slowdown in the economy. This causes an extremely high current price-to-earnings ratio, which also does not accurately reflect market dynamics.
The CAPE ratio adjusts for business cycles and uses consumer price index values to adjust for inflationary pressure on earnings. If the CAPE ratio trends high, then the market often is in a boom period. Conversely, a CAPE ratio that falls for a considerable time tends to indicate a graveyard market. Lastly, a CAPE ratio that turns higher from an extreme low can help to gauge the end of a graveyard market.