Bull Bear Markets and P/E Ratios

I haven’t shown any charts in my writing so far on this site even though I use them regularly to get a feel for the overall market and for entry/exit points. To me technical analysis is just another arrow in the quiver. I’m not terribly interested in philosophical debates on why or how it works; it works for me, that is sufficient. Anyway, in today’s post, I want to share a few charts with you.

The first is the daily on the S&P showing the narrow trading range it has been in since December. This, rather than the “round number effect”, is why decisive breaks of DOW 20K and S&P 2300 are significant. In this struggle, bulls are having a slight upper hand but recent volume is not confirming. Overall, I think there is equal probability to breaking out and sideways, and a lot less to breaking down. A chartist will tell you that such a consolidation pattern will more likely than not resolve in the same direction as prior to the consolidation.

The next chart is from an excellent piece from Doug Short on Bull and Bear markets. It’s well worth a read. I agree with the bull/bear classification he used. The trend lines are mine. Note the red, power-up lines. The bull markets from the 1877 and 1949 lows started with those power moves and then slowed down. The bull markets from the 1921 and 1982 bottoms ended with them. The current bull market has a section, 2011-13, that seemed to follow the same slope. It remains to be seen how it will play out. I drew the last line — obviously one or many different ways it can be drawn — to coincide with my S&P target of 3400 in Q4’18 that I first laid out here.

The discussion on P/E ratios was fascinating. The referenced piece from Ed Easterling is also well worth a read even though I don’t agree with its conclusion. P/E ratios are important, but they are a derived metric, while price should always be the primary signal. The key chart from that work is below. Bull and Bear markets are indicated with green and red bars with historic P/E ratios underneath.

Again the difference in opinion lies in the classification from 2009 onwards. To me the disagreement is profound. If my model is correct, the P/E ratio will continue to expand and will likely approach 40, a territory only before seen during the dot-com bubble. The model also predicts a drastic but not cataclysmic decline that will likely bottom at a historically-still-elevated P/E in 2020. If that turns out to be the case, anyone insisting on a single-digit P/E stands to miss the boat. Profound indeed.

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