Nostradoofus

If this doesn’t alarm you, then nothing will.  Why?  Because P/E ratio is a simple and more or less proven predictor of long-term stock market returns.  Lower is better.  When P/E is 10 times greater than the 138-year average, and 3 times its previous all-time peak, when interest rates are already zero, we are in totally uncharted waters.

The one bright note for stock market investors is that the S&P500 is a weighted index. The financial sector contributed a big chunk of the overall index profits, and most of that went away.  So one interpretation of these graphs is that certain ultra-large-cap stocks are fantastically overpriced, even as many smaller value stocks are still fairly priced.

At minimum, this appears to argue strongly against holding a traditional S&P index fund.  One may do significantly better by owning a low-PE index fund like Vanguard Small-Cap Value Index (VISVX).

(Data source:  Yale economist Robert Schiller’s data series.  Monthly earnings are interpolated from quarterly.  Data set comprises the S&P 500, and an equivalent broad index prior to 1957.  The idea for these graphs came from similar ones posted at Jesse’s Cafe Americain, though he was making a different point I don’t necessarily agree with.)

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This entry was posted on Tuesday, October 13th, 2009 at 5:37 pm and is filed under Investing. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.