Salient to Investors:

Doug Short writes:

  • The S&P 500 is at 18.7 times reported earnings versus the average since the 1870s of 15. In times of critical importance, the conventional P/E ratio often lags the index to the point of being useless as a value indicator because earning can fall faster than price.
  • The negative S&P 500 earnings of Q4, 2008 never happened before.
  • Graham and Dodd attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle and adjusted P/E ratios for earnings over 5, 7 or 10 years. Shiller modified the 10-yr ratio and inflation-adjusted earnings, creating the CAPE ratio.
  • The CAPE ratio closely tracks the inflation-adjusted price of the S&P Composite with a detrended correlation since 1881 of 0.9976.
  • The CAPE is at 24.9 versus the historic average of 16.5 and the all-time high of 44 in December 1999 and 1929 high of 32.6. CAPE ratios were in the single digits at the secular bottoms in 1921, 1932, 1942 and 1982.
  • Historically, whenever the CAPE ratio fell from its top to its second quintile, it has eventually declined to the lowest quintile and bottomed in single digits.

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