I have updated the graphs as of the latest S&P 500 index value as well as the S&P’s estimated reported earnings at the end of 2005Q2 of $62.00 per share, in current dollars, for the past 12 months. Let me make two quick observations about Fig. 1:

1. Earnings are highly cyclical.

2. When earnings are far above the trend-line, it has been a good time to sell the market; conversely, when earnings are far below the trend-line, it has been a good time to buy the market.

3. It is not just the P/E that is important for valuation, but where we are in the earnings advance-decline cycle.

Trying to time these things precisely is like trying to be too cute. I personally think that it is a fool’s game and I refuse to play it. Those who enjoy the game, be my guests.

When I first published Fig. 2, a certified Scam Lover [sic] said, “Nice chart, but flawed logic.” OK, let us look at the logic. The idea of smoothing earnings for a period such as 10 years has been around for a long time. Fig. 1 is the best argument for the use of 10-year, or similar, average. Also, because periods of high inflation, or deflation, would distort the value of the dollar earnings, using inflation-adjusted, or real dollars, has been used widely. The latest to popularize this methodology in determining stock market valuation were by Professors Campbell and Shiller in early 1990s.

They presented their work to the top honchos at the Fed and they accepted it is a valid methodology for comparing valuations over time. BTW, it was this presentation that led to Greenspan’s “irrational exuberance” comment in Dec 1996. Do you know what happened in December of 1996? The P/E in December of 1996, using Campbell-Shiller method, was only exceeded during Q2-Q3 of 1929!

The current P/E is just a tad below what it was in December of 1996. Yes, any logic that comes to a conclusion that one dislikes is flawed logic by definition.

An old friend said today, responding to my general negativity about the US E-Con, that the stock market P/E is not out of line. Which line are you talking about, old friend? The Red line in Fig. 2 is the current P/E line.

Before the bubble of late 1990s this line was only crossed once, for eight months, in 1929! If we use dividends, then the current line was never crossed until July of 1997.

Conclusion: The US stock market, with S&P 500 as the proxy, was never more over-valued than today except for period since the bubble of 1990s and a brief period in 1929. Yes, only a hope that we are in a New Era makes people think that the stock market is not over-valued. Some even claim that it is 20-30% under-valued!

I have provided a historical perspective in pictures and you can make up your own mind.