Monthly Archives: September 2010

The Market War Between Traders and Investors

By Jason Zweig (WSJ)

They’re mad as hell, and they’re not going to take it anymore.

On Oct. 4, mutual-fund executives will convene in Washington at the Investment Company Institute, the trade association for fund managers. People familiar with the situation say a few attendees are determined to push for a plan to restrict high-frequency trading, the rapid market activity that lately has caught the attention of investors large and small.

Using powerful computers and data feeds, high-frequency trading firms typically hold stocks a few minutes and sometimes only a few seconds at a time, churning roughly half of total stock-market volume. Whenever you—and your mutual fund or pension plan—buy or sell a stock, one of these fast-trading firms is likely to be on the other side of the trade.

The problem? While some fund leaders have praised high-frequency trading for making markets more efficient, others contend that the profits earned by fast traders may come partly at the expense of ordinary investors.

Mutual funds and other giant investors are often forced buyers and sellers. When money comes in they must buy stocks; when it goes out they must sell. Their typical buy or sell order is roughly 185,000 shares. Yet the average trade size on U.S. exchanges is only about 100 to 300 shares.

So institutions trade in dribs and drabs. A giant buy order would push up a stock; a huge sell order would knock it down. “Would you leave $100 in cash on the street corner and hope nobody takes it, or would you hide it in your pocket?” asks Andrew Brooks, head of U.S. equity trading at T. Rowe Price. “Information about our order flow is valuable, and we need to protect it.”

Any institutional order for a couple hundred shares can have thousands or even millions of shares behind it. A fast trader that can infer which orders were placed by a big institution gains an insight into how stock prices may be about to change. Whoever gets there first stands to make a tiny profit on each of those trades.

Direct data feeds supplied to fast traders by several major exchanges have customarily included an “order ID”—a kind of tag that, according to several traders, may assist a fast trader in deducing whether a large institution lurks behind a small order. Starting Oct. 4, the NYSE Arca exchange will give customers the option of having these IDs removed from its direct data feeds on orders they don’t want displayed to the whole market.

Traders say the absence of the ID may itself alert rapid traders to the presence of a large, hidden order. “Without the order ID, we don’t think anyone could map the order to any other information to divine that it is part of something larger,” responds Ray Pellecchia, an NYSE Euronext spokesman.

Or consider a type of trading order called a “partial post only at limit.” Here, if a fast trader’s small buy order is rejected instead of executed, the firm can deduce that a large block of shares may lie hidden in reserve, poised to sell at a given price. Thus a trader may be able to get information without executing the trade. Clever use of this order type can increase the trader’s odds of being in the right place at the right time—capturing a splinter-thin, lightning-fast profit before the institution can move.

Chris Isaacson, chief operating officer at BATS Exchange, the third-largest U.S. stock market, downplays such concerns. “This order type is rarely used and would be very complex to implement for the purpose of detecting a large order on the other side,” he says. Such a trader “would have to be willing to take considerable risk.”

“There are aspects of the market structure which give [fast traders] an unfair advantage,” says Manoj Narang, chief executive of Tradeworx, a high-frequency firm in Red Bank, N.J., that trades about 200,000 times a day, turning over roughly 50 million shares. “And those should be changed.”

One such practice: 1,000 shares are offered for sale at $20, and someone wants to buy 2,000 shares at $20. The buyer should be able to purchase the 1,000 shares immediately, while the other 1,000 shares should instantly show as the new “best bid” at $20.

Instead, says Mr. Narang, while the 1,000-share purchase goes through right away, the open order to buy another 1,000 is displayed to the entire market at a slight delay. Traders that can place orders faster can jump ahead, putting them in the best position to buy more shares at $20, in hopes of reselling them at a higher price. Mr. Narang says this occurs “at least tens of thousands of times per day.”

Whom should the market be designed to serve: Short-term traders or long-term investors? Is it serving both fairly?

Hawaiian Airlines (NYSE: HA)

We recently put together an investment presentation where we recommend buying Hawaiian Airlines (HA) and shorting American Airlines (AMR). While HA is one of the best run airlines in the world, AMR is likely to be at a competitive disadvantage for years to come given the latest consolidation in the industry.

CLICK HERE FOR PRESENTATION

Bond Markets Get Riskier

By Carrick Mollenkamp and Mark Gongloff (WSJ)

Bond markets are growing riskier as investors seeking steady returns bid up prices and ignore some early warning signs similar to those that flashed during the credit bubble.

Last week, prices on high-yield, or junk, bonds hit their highest level since 2007, nearly double their lows of the credit crisis. Nine months into the year, companies have sold $172 billion in junk bonds, already an annual record, according to data provider Dealogic.

To some extent, the bull case for junk bonds is based on a declining rate of corporate defaults lately and a belief that, as long as the economy doesn’t relapse into recession, default rates will continue to decline. The financial crisis purged many weak borrowers from the system, and corporate balance sheets are generally stronger today than before the crisis. However, a double-dip recession could hurt another, albeit smaller, wave of borrowers.

The U.S. high-yield default rate fell to 5.1% in August from 13.2% a year ago, Moody’s Investors Service reported recently, adding it expected the rate to fall to less than 3% by the end of the year.

Interest rates paid by companies with strong credit ratings have tumbled this year, falling to 1.8 percentage points above the yields on comparable U.S. Treasury bonds, which themselves are among the lowest yields in decades. Companies with weak credit ratings are paying 6.2 percentage points above Treasurys, down from nearly 20 percentage points in 2008, according to Barclays Capital indexes.

Treasurys have already seen their weaknesses exposed after a recent sell-off. Since the start of September, 10-year Treasurys have lost 2.2% and 30-year government bonds are down 6.9%, compared with a 5.6% gain for the Dow Jones Industrial Average.

The demand for bonds has allowed some of the riskiest borrowers to sell bonds with fewer protections for investors. These provisions, or covenants, prevent companies from taking actions that would hurt bondholders and would protect investors if companies are sold.

The bond boom has so far been a positive for the economy, allowing the U.S. government and major corporations to borrow at cheap rates and giving weaker companies financial breathing room until business picks up.

But continued strong demand by investors can have unintended consequences. Cheap, plentiful debt fueled the housing and leveraged-buyout booms, both of which collapsed after buyers who borrowed too much couldn’t repay loans.

“Bondholders got burned” buying deals in 2005 through 2007 because indentures, or the contracts that govern the bonds, didn’t protect them, said Adam Cohen, founder of Covenant Review LLC, a New York credit research firm. “They said ‘never again,’ but now in a hot bond market, people are buying into those covenant loopholes all over again, and they’re going to get burned again.”

One reason why bond yields keep falling is lack of supply. Despite nearly two years of heavy borrowing by the federal government and nonfinancial corporations, the total amount of debt outstanding in the U.S. is still nearly $700 billion lower than it was at its peak in the first quarter of 2009, according to Federal Reserve data released on Friday.

Still, few analysts say the bond market is anywhere near as risky as it was several years ago.

“It’s more accurate to say that we’re still disgorging the last credit bubble than that we’re starting a new one,” says Harvard economics professor Kenneth Rogoff, who has studied financial crises with Carmen Reinhart of the University of Maryland and notes that new credit bubbles don’t typically form immediately in the aftermath of old ones.

While most analysts don’t think the bond market is in a bubble, they are seeing a repeat of some behavior from the last run-up. “In 2001-2003, clients were desperate for yield and were willing to invest in stuff you could tell was risky because it promised a higher return,” says George Feiger, CEO of Contango Capital Advisors. “You see the same pressure today.”

One of the worrisome developments is occurring in the junk-bond market, where companies are taking advantage of strong demand to sell bonds that have fewer protections for investors than similar bonds sold by the companies in years past.

Some have watered down covenants, which are supposed to protect investors if a company is sold and prevent companies from loading on too much other debt or paying out their cash, which would cause a drop in value of the bonds or make it less likely the bonds they hold would get paid off.

Fifty-seven percent of junk-bond issuers had less-stringent covenants than their previous junk deals, according to an analysis for The Wall Street Journal by Covenant Review which analyzed 58 junk bonds issued in 2010 by companies that previously had issued debt. Just one deal had stronger covenants for investors. Some 41% of the deals had the same covenants.

A decline in investor rights was a marker of a rising bubble in the years leading up to the market collapse of 2008. Just like then, investors are scrambling to invest in deals, some of which are completed in a day in what are called on Wall Street “drive-by” offerings.

“It reflects a weakening in covenant protections even below those existing at the peak of the market, in 2006 and 2007,” Alexander Dill said in a May report from Moody’s.

When Tenet Healthcare Corp. sold $600 million in junk bonds in August, investors had fewer protections than they had in previous Tenet bonds. The bond deal from the Dallas hospital operator and health-care company lacked an asset-sale covenant, which would have forced the company to use proceeds from the sale of a material asset to buy another asset, make capital expenditures or repay bond investors.

Those covenants also prevent companies from using cash from asset sales to pay salaries. The recent Tenet deal also lacks a restricted payment covenant, which blocks dividend payouts.

In an email statement, Tenet spokesman Rick Black says the recent debt sale was a private placement to sophisticated investors who understand credit markets and are “extremely well-informed about prevailing market terms” including covenants.

He added: “‘The market’ dictates the terms, condition and pricing of debt offerings.”

Two junk bonds issued by Chesapeake Energy Corp., an Oklahoma City company that is the second-largest U.S. natural-gas producer, illustrate how new bonds are being sold. In an August sale, Chesapeake sold $2 billion worth of junk bonds maturing in eight and 10 years. Chesapeake is using the bond sales to pay down existing debt and for general corporate use, the company said in an August news release.

According to Covenant Review, neither bond offers a “change-of-control” covenant. When that protection is included and a company is sold, bondholders can sell back their bonds at 101% of par value. In an Aug. 9 report to clients, Covenant Review said Chesapeake “is yet another issuer trying to take advantage of a hot market by quickly passing off a materially worse covenant package.” Mr. Cohen says that analysis reflects both the lack of a change of control provision and weak covenants that protect how assets can be pledged.

In an interview, Chesapeake Treasurer Jennifer Grigsby says investors didn’t want the covenant in the recent sale. “We were advised by our underwriters that we did not need to add a change of control” covenant in the deals “in order to achieve a successful sale of the bonds,” says Ms. Grigsby.

Ms. Grigsby acknowledges the sale took place quickly, but notes the offering was three-times oversubscribed and if investors had concerns after having more time to review the bond documents, they would have been selling the bonds. Instead, the bonds now are trading at 104 cents on the dollar. She also says the covenants limit Chesapeake’s ability to use its oil and gas properties to secure financing.

A spokesman for lead underwriter Credit Suisse Group said in a statement, “Chesapeake is viewed by investors as a high-quality issuer and has not included a Change of Control put provision in any of the bonds they have offered to U.S. high-yield investors for several years.”

Klarman: Opportunities For Patient Investors

At the CFA Institute 2010 Annual Conference in Boston (held 16–19 May), Jason Zweig sat down with legendary investor Seth Klarman to gain insights into Mr. Klarman’s successful approach to investing. The complete transcript can be found HERE. 
 
 

Update: QXM Gets Much Awaited Catalyst, Jumps 40%

A month ago, we wrote an article highlighting Qiao Xing Mobile Communication (QXM), a small Chinese company which traded below its net cash value (QXM was the last stock added to the ValueHuntr Portfolio) At the time, we indicated our willingness to wait for a catalyst to unlock this value, as the company’s cash was worth between $4 and $5 per share, but the company was mysteriously trading at the depressing level of $2.6 per share. We referred to this as “an opportunity with asymmetric payoff with the odds of a positive return extremely tilted towards shareholders”. A month later, the much waited catalyst seems to have arrived in the form a private takeover proposal.

The company recently announced that it has received a proposal from its parent company, Qiao Xing Universal Resources, Inc. (Nasdaq: XING) regarding the acquisition of all outstanding ordinary shares of QXM that XING does not currently own. The proposed transaction, if completed, would result in QXM becoming a privately-held company. XING has proposed to offer 1.9 shares of its common stock plus US$0.80 in cash for each QXM share held by persons other than XING. XING filed its letter of intent with the Securities and Exchange Commission on Form 6-K on September 8, 2010. The letter of intent is available on the SEC’s website at: http://tinyurl.com/LOA-XING .

Strategically, this deal is headed for failure. Previously, XING was engaged in telecommunication terminal products business and changed its focus to the resources industry in 2007. The idea of a miner buying out a mobile handset business is a big warning sign to me. Therefore, taking profits at this level seems reasonable.

Francisco Parames To Speak at NYC Value Investing Congress

The Value Investing Congress has just announced that Francisco Paramès of Bestinver Asset Management will speak at the New York City Value Investing Congress scheduled for October 12 and 13.  According to John Schwartz, co-founder of the Value Investing Congress, Mr. Paramès has been called “The Warren Buffett of Spain” due to his impressive historical returns.  The following biographical information on Mr. Paramès is from the Value Investing Congress website:

Francisco Garcia Paramès is the CIO of Bestinver Asset Management ($4.6 Billion AUM). Mr Paramés joined Bestinver in 1989 as a stock analyst, but his passion for investing led him to the asset management area and soon after, he was named CIO.

Self-taught, his management style is based on the strict application of value investing principles, within a framework of a profound knowledge of the Austrian theory of economic cycles.

In 2009 Morningstar elected him as the Best European Manager in European Equities due to his historical returns (16.9% annualized in Spanish equities over the last 18 years and 9.7% annualized in global equities over the last 12 years) and consistency of his investment philosophy.

Mr. Parames has an Economics degree from the Universidad Complutense and holds an MBA from IESE Business School (Madrid – Spain).

ValueHuntr readers qualify for a Steep Discount for the Value Investing Congress.  Act quickly because the discount expires THIS MONDAY, September 13.

The Traders Who Skip Most of the Day

By Kristina Peterson (WSJ)

On the day the “flash crash” bludgeoned the stock market and chaos swept over the floor of the New York Stock Exchange, the founders of Briargate Trading were at the movies.

Rick Oscher and Steven Rubinstein weren’t playing hooky. Briargate, a proprietary-trading firm that the two former NYSE floor “specialist” traders started in 2008, is mostly active at the stock market’s open and close.

In between, when market activity typically drops, the Wall Street veterans play tennis in Central Park, take leisurely lunches, visit their children’s schools and work out at the gym. Dress shoes have been replaced with flip-flops, slacks with cargo shorts. Once during market hours, they walked about five miles and crossed the Brooklyn Bridge to try Grimaldi’s pizza.

“We actually planned on working a full day,” says Mr. Oscher, wearing a white polo shirt and blue-plaid shorts. “But from 11 to 2, the markets are pretty quiet—what’s the point? As a specialist, you have to stand in your spot all day and we did that for 20 years.”

Briargate—an anagram of “arbitrage”—isn’t the only firm taking an extended recess during the 6½-hour U.S. trading day. Trading has become increasingly concentrated in the first and last hours of the session.

Those two hours now make up more than half of the entire day’s trading volume, according to an analysis of data provided by Thomson Reuters. In August, the first and last hour generated nearly 58% of New York Stock Exchange primary volume, up from 45% in August 2005, the analysis shows. The rise of high-frequency trading, where algorithms are used to exploit small discrepancies in high-volume situations, amplifies the concentration of trading at the beginning and end of the day, analysts say.

Heavy trading in the first hour is largely due to the accumulation of orders placed by individual investors and their brokers after the previous day’s close, mutual-fund activity and new strategies deployed by institutional investors based on the latest research and overseas trading, says Adam Sussman, director of research at Tabb Group, a financial-markets research firm. Meanwhile, funds that track stock indexes often wait until the final hour to execute trades to better reflect the benchmark measures’ last prices.

Focusing trading on those times could limit gains, but Messrs. Oscher and Rubinstein are at peace with that. “Would you rather play tennis or make an extra $80? It’s a lifestyle question,” says Mr. Rubinstein, who sometimes works remotely from Florida. “I can go play 18 holes of golf and then come back and trade and that’s a workday.”

“If someone offered us three times what we make to do a real job, we wouldn’t do it,” Mr. Oscher says. “Money isn’t everything. Plus, we’d make terrible employees.”

The men, both 42 years old, met 12 years ago as specialists manning posts 10H and 11H for Van der Moolen Holding on the NYSE floor. They rose to oversee floor operations for the Dutch market-maker, but saw the writing on the wall as the era of specialists faded. Van der Moolen eventually sold its specialist arm to Lehman Brothers in late 2007 and filed for bankruptcy in 2009.

The advent of automated trade execution rendered people who could see and direct the order flow less crucial. There was a peak of nearly 50 specialist firms working the NYSE floor in 1990. That has dwindled to five now.

In 2008, the men joined forces with a programmer from Van Der Moolen and started Briargate. The five employees that now comprise Briargate work out of an apartment in a luxury-hotel and condominium complex on Wall Street.

Briargate trades mostly stocks, using computer algorithms that still require human decision-making. Sometimes the firm’s programmer is left in charge when the rest of the staff leaves the office.

Mr. Oscher said the firm, which trades only its own money, hedges its risks “so there isn’t any scenario that would move our profit and loss beyond boundaries of comfort.” Briargate says it didn’t sustain losses during the May 6 flash crash because it closes its books when the market tends to be volatile. “We actually had a pretty good day,” Mr. Oscher says.

While the firm declined to disclose their returns, Messrs. Rubinstein and Oscher say they make more than they did in their later, leaner years as specialists, though not as much as they did in the late 1990s before the industry started to consolidate.

Mr. Oscher says their compensation is “in line” with what they formerly made as specialists. Successful specialists could make upward of $500,000 at the industry’s peak, while partners could bring home more than $1 million.

Both feel their freedom is fragile, as trading invariably carries risks. Says Mr. Oscher: “We say all the time—these are the good old days.”

It’s Warren Buffett vs. Betty

By Dennis Berman (WSJ)

Try to imagine back to those Nixonian mists of 1973. A small Pasadena, Calif. savings and loan named Wesco Financial Corp. is about to merge with a local suitor. The deal alarms a duo of up-and-comers, 43-year-old Mr. Buffett and colleague Charles Munger, who think the $45 million offer is a rip-off.

They are invited by Elizabeth “Betty” Caspers Peters, the founder’s daughter, to break up the deal. They eventually take over Wesco themselves, accumulating an 80.1% stake.

“I liked Mr. Buffett enormously,” Ms. Peters said in an interview Monday. But Ms. Peters, who was 47 at the time of the deal, had one demand: that some Wesco shares continue to trade publicly.

Good move. Those few shares are up roughly 50-fold since early 1978, outpacing gains at both Berkshire Hathaway and the Dow Jones Industrial Average by more than three times. The old S&L is gone. Sleepy little Wesco, transformed into a collection of insurance, steel-processing and furniture rental businesses, is now worth $2.6 billion.

Today, Ms. Peters is 84 and still on the board. She is fiercely proud of Wesco, having taken it public in 1959, when, she reminds, few women ever stepped in a board room.

“Happily, I’ve been part of the ride,” she says of Berkshire.

Late last month, Mr. Buffett and Mr. Munger, Wesco’s chief executive, offered to buy out Wesco’s remaining 19.9% for roughly $500 million. Both men didn’t respond to requests for comment. Mr. Munger’s latest shareholder letter may have been the only time in history a CEO disparaged his company and its employees. “Business and human quality in place at Wesco continues to be not nearly as good as Berkshire,” he wrote.

They have priced their offer to Wesco’s 5,400 minority shareholders accordingly. They are willing only to pay Wesco’s book value, the basic calculation of a company’s assets minus liabilities.

Wesco has convened a committee of independent directors to evaluate the deal. They would be foolish to press for more, Mr. Buffett says, because they won’t get it. “No hard feelings” if directors won’t accept, he wrote.

Will Wesco ask for an improved offer, knowing that Berkshire could walk away? The answer will come in part from the woman who faced the same judgments back in 1973: Ms. Peters, now the pivotal player among the three-member independent committee. She holds about 5% of non-Berkshire shares, the third-largest bloc.

Thus sets up one of the most unlikely merger face-offs of 2010: Betty vs. Buffett.

Wesco is the oddest of ducks. It has no employees and virtually no public presence. Wesco’s primary appeal, it seems, is its annual meeting, where the cantankerous Mr. Munger holds forth on philosophy, and, occasionally, business. “We would pay to keep it public so we could continue to have an annual meeting,” says Glenn Tongue, managing partner at T2 Partners and a Wesco holder.

There is little room for sentiment in the work of special committees. They must determine whether shareholders are getting a fair, if not optimal, offer. Lawsuits await those who don’t.

Berkshire’s offer is based on Wesco’s book value when the deal closes. That value was $352 at the end of June. The stock traded at around $360 Friday, having hit $416 over the past year.

There is plenty to suggest that Wesco is indeed worth Berkshire’s offered book value. About $2 billion of Wesco’s $2.5 billion of assets is simply a pool of stocks and bonds; its main appeal is the management skill of 80-year-old Mr. Buffett and 86-year-old Mr. Munger. Wesco’s operating businesses perform meekly.

Unsatisfied shareholders will point out that Wesco has traded well above its book value at various times in the past two years. They might also argue that the company’s insurance operations, tightly aligned to Berkshire, might be better valued in line with its parent, which trades at 1.4 times book.

The market consensus is that Ms. Peters will take Berkshire’s offer. The price is “fair and appropriate,” says Mr. Tongue. “It’s not like you’re buying brand equity in this company. It has none.”

Ms. Peters won’t comment about the offer, only saying that “I believe I’m the best person on that board to represent the minority shareholders.”

So is she willing to get tough with the man whom she so admires? Politely, but firmly, she ends the phone call. She’s busy, she says, with grandchildren at her home in Napa Valley. “Right now we’re picking peaches.”

Bond Market Bubble to Burst Sooner or Later

The current bubble in fixed-income markets is set to burst at some point, and will surely drive funds into stocks. The market for U.S. Treasury bonds has become inflated as banks exploit benchmark borrowing costs near zero to boost purchases.

Although moving into bonds is a natural reaction to uncertain economic conditions, income from the Treasury market is low and real interest rates are negative so investors should look elsewhere to get more bang for their buck, particularly high-yielding companies with good growth prospects.

The threat of deflation, quantitative easing, and liability-driven investments by global pensions is also driving bond prices higher. Moreover, some pensions are leveraging up on bonds to meet their actuarial returns. And banks are borrowing at zero on the short end, purchasing bonds to make the easy spread and trading in higher yielding risk assets all around the world.

With hopes of a V-shaped recovery fading, income-generating bonds look like a smart play. However, as Jeremy Siegel writes in an op-ed published recently in the Wall Street Journal, that “those who are now crowding into bonds and bond funds are courting disaster”.

The Decline of the P/E Ratio

By Ben Levisohn (WSJ)

As investors fixate on the global forces whipsawing the markets, one fundamental measure of stock-market value, the price/earnings ratio, is shrinking in size and importance.

And the diminution might not stop for a while.

The P/E ratio, thrust into prominence during the 1930s by value investors Benjamin Graham and David Dodd, measures the amount of money investors are paying for a fcompany’s earnings. Typically, companies that post strong earnings growth enjoy richer stock prices and fatter P/E ratios than those that don’t.

But while U.S. companies announced record profits during the second quarter, and beat forecasts by a comfortable 10% margin, on average, the stock market has dropped 5% this month.

The stock market’s average price/earnings ratio, meanwhile, is in free fall, having plunged about 35% during the past year, the largest 12-month decline since 2003. It now stands at about 14.9, compared with 23.1 last September, based on trailing 12-month earnings results. Based on profit expectations over the next 12 months, the P/E ratio has fallen to 12.2 from about 14.5 in May.

So what explains the contraction? In short, economic uncertainty. A steady procession of bad news, from the European financial crisis to fears of deflation in the U.S., has prompted analysts to cut profit forecasts for 2011.

“The market is worrying not just about a slowdown, but worse,” said Tobias Levkovich, chief U.S. equity strategist at Citigroup Global Markets in New York. “People want clarity before they make a decision with their money.”

Three months ago, analysts expected the companies in the Standard & Poor’s 500-stock index to boost profits 18% in 2011. Now, they predict 15%. Mutual-fund, hedge-fund and other money managers put the increase at closer to 9%, according to a recent Citigroup survey, while Mr. Levkovich’s estimate is for 7% growth.

“The sustainability of earnings is in doubt,” said Howard Silverblatt, an index analyst at S&P in New York. “Estimates are still optimistic.”

Equally troublesome, analysts’ forecasts are becoming scattered. In May, the range between the highest and lowest analyst forecasts of S&P 500 earnings per share in 2011 was $12. Morgan Stanley predicted $85 a share, while UBS predicted $97 a share. Now, the spread is $15. Barclays said $80 a share; Deutsche Bank predicts $95.

When profit forecasts are tightly clustered, it signals to investors that there is consensus among prognosticators; when they diverge wildly, it shows a lack of clarity. The P/E ratio tends to fall as uncertainty rises, and vice versa.

“A stock is worth its future earnings, but that involves uncertainty,” said Jeremy Siegel, professor of finance at the University of Pennsylvania’s Wharton School. “The more uncertainty there is, the lower the P/E will be.”

Not only is the P/E ratio dropping, it also is in danger of losing some of its prominence as a market gauge.

That is because, with profit and economic forecasts becoming less reliable, investors are focusing more on global economic events as they make trading decisions, parsing everything from Japanese government-debt statistics to shipping patterns in the Baltic region.

To some extent this is in keeping with historical patterns. P/E ratios often shrink in size and significance during periods of uncertainty as investors focus on broader economic themes.

P/E ratios fell sharply during the Depression of the 1930s and again after World War II, bottoming at 5.90 in 1949. They plunged again during the 1970s, touching 6.97 in 1974 and 6.68 in 1980. During those periods, global events sometimes took precedence over company-specific valuation considerations in the minds of investors.

There have been periods when the P/E ratio was much more in vogue. A century ago, the buying and selling of stocks was widely considered to be a form of gambling. P/E ratios came about as a way to quantify the true value of a company’s shares. The creation of the Securities and Exchange Commission during the 1930s made financial information more available to investors, and P/E ratios gained widespread acceptance in the decades that followed.

But thanks to the recent shift toward rapid-fire stock trading, the P/E ratio may be losing its relevance. The emergence of exchange-traded funds in the past 10 years has allowed investors to make broad bets on entire baskets of stocks. And the ascendance of computer-driven trading is making macroeconomic data and trading patterns more important drivers of market action than fundamental analysis of individual companies, even during periods of relative calm.

So where is the P/E ratio headed in the short term? A few optimists think it could rise from here. If corporate borrowing costs remain at record lows and stock prices remain depressed, companies will start issuing debt to buy back shares, said David Bianco, chief U.S. equity strategist for Bank of America Merrill Lynch. As a result, earnings per share would increase, he said, even if profit growth remains sluggish, and P/E ratios could jump with them.

But today’s economic uncertainty argues against that scenario. Consider that while P/E ratios dropped during the inflationary 1970s, they also fell during the deflationary 1930s. The one common thread tying those two eras of falling P/E ratios: unpredictable economic performance.

“We’re looking at a more volatile U.S. economy than we experienced in the last 30 years,” said Doug Cliggott, U.S. equity strategist at Credit Suisse in Boston. “The pressure on multiples may be with us for quite some time.”