Bear Case and Historical PE Ratios

By -

From a Sloper this morning………

I know most Slopers lean towards the bear side, and for good reasons.  Many of of the reasons I have had for leaning to the bearish side has been proven over time to be false in the near term which has cost me dearly.  Longer term however, the truth is that no sustainable bull market ever began while the PE was over 20.  It will simply be difficult for me to become a bull until the PE fell below 10.  No sustainable bull market ever began without the PE dipping below 10.

What I have attempted to do below is to show what prices have done since the depression when the PE reaches extremes.  The top chart is the S&P and the bottom chart is the PE chart.  Obviously, when the PE’s are high it pays to invest in a much more guarded fashion while when the PE’s are low, it pays to become much more bullish.  


Where would prices need to pull back to bring the PE back below 10?  When the S&P bottomed in 2009 at 666, the PE ratios bottomed at 15.  Assuming we are entering a new bear market now at the end of QE2, and the market drops over the course of the next year or a little longer, the next touch of the trend line would be somewhere between 700 and 750.  The chart below depicts what this could look like.

Back in 2002, the S&P was around 800 and PE's were about where they are now in the 23.5 area.  My guess is that should prices come to the trend line, you will see PE's close to a bullish bottom but not quite.  It depends on how well you can interpolate the data.