Concerns About P/E Ratio are Baffling
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Bernie Schaeffer Schaeffers Research.com |
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"Chartists point out that when the S&P passed 1,120 it had recovered exactly half the ground it lost from its October 2007 peak to its March 2009 trough. Traders take these things seriously, and the S&P had tried and failed to breach 1,120 several times before doing so. Breaking through is a bullish sign and should mean that it can keep going until its next level of resistance at 1,228 (where it will have retraced 61.8 percent of its losses). Fundamentalists look to the price/earnings ratio, which, on a cyclically- adjusted basis (taking price as a multiple of earnings over 10 years), is now back above 20. The historic average is 16.3, and the market traded below 20 on this measure from 1969 to 1993. It is only a year since it dropped below 20. On this basis, the S&P could certainly go up further. It reached 22 in the late 1930s before the second dip of the Great Depression, and peaked above 40 during the dotcom bubble. But fundamentally, stocks are already expensive, and are still in a bear market."
(Financial Times – "Short View: Awaiting the bear" – 1/5/10)
Schaeffer's addendum: Regarding the technical take in this piece, I'd suggest the next level of interest on the S&P 500 Index is not the 61.8% Fibonacci level at 1,228, but the 160-month moving average (see accompanying chart), which is currently just overhead at about 1,158. As I've previously noted, this long-term moving average supported the market at the 2002-2003 bottom, and the 160-month break in October 2008 opened the bearish floodgates. A monthly close above this trend line would be a very important next step in re-establishing whether or not the market is in bull mode.
The fundamental take in this article completely baffles me, as I've never before seen a market referred to as being "fundamentally" in bull or bear mode based on price/earnings ratios. You may base your bull or bear assessments on precise price levels, such as Fibonacci or moving averages, or you may be in the "I know one when I see one" camp (Curtis Faith, in his new book Trading From Your Gut, suggests a very visual, chart-based approach to determining the trend of the market).
But, as I see it, the price/earnings ratio is a non-factor in any bull vs. bear assessment. High P/E ratios can be characteristic of bull markets near valuation peaks as prices far outrun earnings, or they can occur at bear market bottoms when earnings essentially disappear, or anywhere in between. And then there's always that pesky question of accurately defining "high P/E," an assessment that is often more of a reflection of the analyst's market bias than an objective evaluation. I'd also point out that as early as mid-2009, many analysts began referring to stocks as "overvalued."
Bernie Schaeffer:
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