The Stack Market

The long-term rule of thumb for fair valuation of the Standard & Poor's 500 price to earnings (P/E) ratio used to be 14. Generally speaking, when the PE ratio was above 14, stocks were considered to be expensive, when it was below they were cheap. When the market's collective PE climbed to 20, you started looking for vacant lots, and when it fell to 7, you started to look for publicly traded mattress stores. That's what the game was like from about 1936 into the late 1980s from the sell crest (red line) to the buy trough (green line). Twenty years on the late 80s, the definition of value investing in equities has changed by almost an order of magnitude.

The price investors were willing to pay for a dollar of earnings greatly increased during the late-90s dot-com boom and continued through the early-ought dot-com bust. Recently, as a result of the plunge in earnings and stock market rally following the 2008 Wall Street bailout, fiscal stimulus, and job-less recovery, the ratio spiked again and peaked at a PE of 144. With 97% of US corporations having reported for Q2-09, the S&P 500 PE ratio currently stands at a vertiginous 129. There are more things in heaven and earth, Horatio, than are dreamt of in your philosophy.

Like Hamlet, Horatio was a student at the University of Wittenberg. He was a model of rationality, was probably an economist, deeply uncomfortable with the notion that Hamlet was talking with his father's ghost. But it is precisely from the lips of our father's ghosts that we hear condemnations of the ugly suppurating brutes that stand before us wrapped in silk and garlands, announced by jesters waving sparklers to the pensions of Elsinore. The PE ratios have gone vertical, Ophelia has climbed out onto a fallen branch over the river, and it might mean something.