Tuesday, June 02, 2009

Does P/E matter anymore or should it?

So, I am taking a good ribbing from a friend this morning, as he posted this comment on my Blog: "So Charles when should we REALLY listen to you? :)" It reminds me of the same comments I got when the markets climbed the wall of the Nasdaq in 2000 and I was telling people to go to cash. I said then as I say now, Time will tell. It's too early to proclaim either defeat or victory. The move up in the markets the past few days seem to break out of the range of the past 2 weeks for the Dow from 8,200 to 8,600 but as I said earlier it just means we are in the larger range now which could reach as high as 9,300. So I still watch like everyone else and try to look for clues in the tea leaves. Here's what I found this morning. It's a piece posted by Chart of the Day on May 22nd and even more useful today with a rising market.

The article is on the P/E ratio of the S&P 500 depicted in the chart above. Here's his comments about the chart and the data: "Last week’s chart illustrated the current plunge of S&P 500 earnings. Today’s chart illustrates how this plunge in earnings has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive.

From 1936 into the late 1980s, the PE ratio tended to peak in the low 20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s) and the dot-com bust (early 2000s). As a result of the current plunge in earnings and the recent 2.5 month stock market rally, the PE ratio has spiked to the low 120s – a record high."

It has good merit and should be a cautionary note for all investors and a boost for the Shorts confidence.

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