Valuation Highest Since 1880...maybe, maybe not

CYCLICALLY ADJUSTED PRICE EARNINGS RATIO 

Excerpts from an article by by Daryl G. Jones, at Hedgeye…

“Late last week I wrote a research note on the valuation of the S&P 500 index... 

When looking at the valuation of the S&P 500, we prefer to use CAPE, or cyclically adjusted price to earnings. CAPE is a metric popularized by Yale Professor Robert Shiller that looks at a market P/E that is adjusted for inflation and normalized for cycles.  Currently, CAPE is showing that the S&P 500 is trading 21.9 times earnings, which is the highest level since July 2011 and in the top quintile of market valuations going back to 1880 ...” Full article at http://www2.hedgeye.com/

That is the valuation metric that John Hussman uses.   It is, however, subject to questions.  It is really just a glorified trailing P/E.  (Trailing P/E would be the current Price divided by last quarter’s earnings.)  The Shiller Cyclically Adjusted PE uses ten-year average earnings divided by today’s price.  Since it covers 10-yrs, it is adjusted for inflation.

The trailing earnings average over the past 10-yrs includes two major crashes so we really must question the CAPE approach.  Frankly, I haven’t had time to get into Valuation in detail, so I don’t have an informed opinion.  Let’s just say I am skeptical about the CAPE approach for P/E.

Here’s some more on the subject from an Oct 2011 Seeking Alpha article by Chuck Carnevale:

“Prof. Shiller's cyclically adjusted PE ratio (CAPE) calculates an average of 10 years of S&P 500 earnings, which is used as the level of earnings with which to divide into the current price of the S&P 500 in order to determine the CAPE PE ratio. This calculation, which theoretically takes into consideration the cyclicality of the S&P 500's earnings, is promoted as being superior to forecasting future earnings. However… the only way that it can be of true value is if its implied forecast is correct in future time. Of course, it should also be recognized that this is no different than any other forecast methodology. The veracity of the assumptions underlying the hypothesis can only be proven if they produce an accurate future level of earnings.” 

Basically, he argues that (in October) the P/E was extremely low.  Even back then the CAPE was high.  He discussed  a number of problems with CAPE.  Full story at…
http://seekingalpha.com/article/299217-prof-shiller-and-cape-may-be-correct-generally-but-the-market-is-currently-cheap

The S&P 500 went down about 1/3% today, Tuesday, to 1406.  VIX was up about 4%. 

NTSM ANALYSIS

Today, Monday at the close, the NTSM analysis moved back to BUY, because both Volume and Price action is positive.  VIX is now neutral. The rise in VIX is a worry.

MY INVESTED POSITION

I bought back into the stock market at S&P 500, 1155 on 7 Oct after the 6 Oct NTSM buy signal.  I remain 100% long in the long-term portfolio (100% stocks in the 401k.). (See the page “How to Use the NTSM System” – the link is on the right side of this page).