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Weekend Stock Market Analysis

(7/31/10)

This week let's revisit work done by Robert Shiller which compares the historical PE Ratio (blue line) versus the Inflation Adjusted S&P Composite (red line) going back to 1899.   The long term historical average PE Ratio based on Shiller's work is 16.3 going back to 1899 as denoted by the black line in the chart below.  As you can see back in early 2009 the PE Ratio dropped below the long term historical average (point A) which was followed by an 83% rally in the S&P Composite.   Thus it appears the Institutional Money thought it was undervalued enough to justify buying it just below the PE Ratio's long term average.   

Meanwhile since 1900 based on Inflation Adjusted values major market bottoms haven't occurred until the PE Ratio has dropped back to at least the 7.0 level (points B) as denoted by the purple line.   These occurred in the early 1980's, early 1930's and further back in the early 1920's.   Thus the question is will Shiller's PE Ratio have to drop back to the 7.0 level at some point in the future before the next major bottom occurs for this current cycle? 

Finally the last thing I would like to point out is that there is a defined upward channel (green lines) going back to the late 1920's and early 1930's.  Thus the second question is will the bottom of this channel eventually be tested at some point in the future?  

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