Thursday, March 27, 2008

Stock Market Long-Term Valuation

(Angry Bear) This mornings Wall Street Journal article on the stock markets lost decade gives me an excuse to publish one of my favorite charts-- the really long term history of the stock market PE back to 1871.
If you listen to Wall Street strategist they frequently talk about the long term average of the stock market PE being 14.5 as if their were some long term tendency for the market to trade near its long term average. But this chart shows that there is no central tendency for the market to trade around its average. The only tendency is for the market to swing from a PE of under 10 to a PE of over 20. If you do a frequency diagram you find that it is fairly flat at most values between 10 and 20. Until the late 1990s bubble the decision rule to sell when the market PE rose over 20 had a perfect history.

Today's WSJ article gave the impression that the lost decade should be setting the stage for a period of superior returns as the market returns to the mean. But this chart implies that the market still has a lot of downside as the market PE has only fallen to about its long term average
and still has a tendency to fall to below 10.

But that is what makes a market, you pays your money and takes your pick.

P.S. I have added a chart comparing the market and cash since the PE went over 20 in mid-1997.





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