Source: Robert Shiller, Princeton University
- From the valuation chart above we see that expansion and contraction of the PE (price to earnings ratio) is the major factor in determining stock market performance. This is in contrast to Wall Street's assertion that the market tracks earnings growth uniformly. The fact is that Wall Street hype and fear drive the market to extremes of overvaluation and undervaluation, while earnings and GDP growth are relatively modest and linear. (see chart of historical inflation adjusted market growth vs. earnings growth)
- Major stock market bubbles with PE's well above 20 have been historically followed by multi-decade bear markets where PE's declined into single digit territory. At the end of 2009 the PE on the above chart was 21.
- After the mega-bubble of the 80's/90's, the Greenspan Fed flooded the economy with easy money in 2001 creating a real estate bubble and keeping the stock market from reaching its single digit PE bottom. The after-math of the 2008/2009 crisis resulted in the market falling to a PE of around 13, but again the Fed's easy money machine interrupted the bottoming process.
- Unless this time is different, we are likely to see a single digit PE bottom before this bear market cycle is finally over and the next sustainable bull market begins. Subscribe now to see what our latest newsletter says about the valuations of foreign stocks, bonds, commodities, real estate, and gold.
