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750
is an Important Number for the S&P500 During my constant research into the ebb and flow of the markets I found that at present the number 750 is a very important number for the S&P 500. Why? Simple, if you look at the long-term graph of the S&P500 going back to 1990. There was a pronounced uptrend in place actually from 1980 (the start of the major Bull market), which is shown by the black line on the chart below. As you can see, I have continued this line to the present day and it gives us a reading of approximately 750. As can be clearly seen on the chart below the true start of the 'Bubble' was 1995. If the S&P 500 drops back onto the long-term, pre-bubble trend line at 750, what will this mean? I will explain
I went to the S&P 500 website to have a look at the PE ratio. What I found using AS REPORTED figures (i.e. the GAAP figures for the last 4 quarters) were earnings of $49.08. Now on December 31 2003, the S&P 500 closed with a reading of 1111.92. So we had a PE ratio of 22.65. It is now slightly higher. For a perspective of the importance of PE ratios throughout history, please read Joe Miller's excellent article at Gold-Eagle. We know from the historical perspective that a PE ratio of 20 is overvalue, a PE ratio of 15 represents fair value, and a PE ratio of 10 is undervalue. We also know that Bear markets normally end at PE ratios slightly below undervalue around about 7. We know that earnings for the S&P 500 are currently $49.08 PE20
= 981.6 OVERVALUE The important figure is that at fair value we have an S&P500 reading of 736.2 which is very close to the long-term trendline at approximately 750 drawn above. It is as if the bubble never actually happened!!!! EVERYTHING POINTS TO 750 AS A VERY IMPORTANT FIGURE AS IT NOT ONLY IS THE NATURAL CONTINUING TRENDLINE, BUT IT ALSO REPRESENTS A PE AT FAIR VALUE. This tells me that this new mini Bull market is not the real thing as not only was it launched from a historically high PE ratio and is largely a creation of sacrificing the USD to buy earnings. For example if McDonalds sell a meal in Paris and makes 1 Euro of Profit or EARNINGS when the exchange rate was 1 to 1, they have 1 dollar of earnings. They now make the same 1 euro profit, but at an exchange rate of 1 to 1.25 they have 25% more dollars an extra 25% of dollar denominated profit over the previous year. It seems to me that most of the so-called earnings recovery has largely been made by cost cutting and more importantly currency gains. Now if interest rates rise that will not only stop the relative decline of the dollar and therefore the prime source of recent easy earnings growth, but also increase financing costs on Americas massive corporate, Personal, and Government debt, it will also stop the Bond carry trade therefore leading to a bond sell off and a further increase in real rates as yields rise. NONE OF THIS IS GOOD FOR STOCK MARKET EARNINGS. Also can you imagine George and Alan raising rates in an election year knowing full well that it was a weak economy that did his father in!!!! I DON'T THINK SO. However If they don't raise interest rates, the dollar keeps sliding American consumers then ask 'why is everything getting more expensive, but you tell us inflation is so low already the official inflation figures look very massaged! (Talking of which has anybody seen the PPI figures recently?) Finally just maybe the long suffering FOREIGN purchasers of American bonds say enough is enough. It is all a bit of a mess really!!!!! to put it mildly. I think that the inevitable phase 2 of the bear market will bring valuations down to at least historic fair value and probably to undervalue. The NASDAQ led the broad market up in the BUBBLE then down after the BUBBLE and has now again led the market up with this mini bull. It has also been the first index to show distress recently. It seems to be an important lead indicator for the DOW and S&P500. Personally we have sat the recent trading period out due to too much uncertainty. We believe that it is 'better to make nothing than lose something'. I suspect that this mini bull started too early for the election and has not had a decent correction in the last year. I therefore have a nagging feeling that the S&P500 may go down to its 200MA currently at 1048 or even slightly below and then the stops will be pulled out to get a nice election bounce so that CNBC can tell us all that 'it was just a healthy correction in an ongoing bullmarket'. However history shows that markets will eventually have their way. Just ask the Japaneese!! As the great Bear reasserts himself after the election--AS HIS BUSINESS IS NOT YET FINISHED--he will probably be joined by baby bears in the Bond and Real estate markets. We will then enter a desperate currency period of beggar thy neighbour and tarriffs. Gold will break out of its long-term inverse relationship to the USD and rise against all currencies. This will be the point that Gold really takes off as American purchasers are also joined by the Europeans who have not seen Gold rises relative to the Euro YET. I have not even mentioned China's increasing appetite not only for Gold but all commodities or a rapidly growing and more affluent India, the world's largest Gold market. This will be the point that Gold reasserts itself as the true store of value--the currency of the kings. If you add to this the ongoing major supply and demand difficulties largely solved through recent years by central bank sales, how much have they physically got left? Together with the potential for a major short squeeze with the Gold cartel, the future looks very good for gold and even better for silver. Maybe the Fed, CNBC and Wall Street are correct, this time is different. History however shows that bubbles and manias all end the same way with gross overvaluation followed by gross undervaluation. Personally I will go with history. As Jesse Livermore the greatest ever speculator stated: “Another lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market to-day has happened before and will happen again. I’ve never forgotten that.” We live in interesting times. Ceri Shepherd
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