Hi Toof, Re: Pretty Picture................
I generate the Relative Valuation (RV) graphic in Excel. I've been keeping the data since the early '80s. The idea came from something I heard Elaine Garzarelli discuss once. She said that the sum of the average market P/E and short term interest rates tends to average around "20." Very small deviations from 20 would indicate bullishness or bearishness in the market place.
She said you can have a P/E of 10 but it's not bullish if interest rates are 12% (sum = 22). Further, if you have a P/E of 19 the market isn't necessarily bearish if interest rates are just 1% (sum = 20). So, it's the sum of s/t interest rates and P/E that determines whether the market is over or under valued.
She felt P/E by itself wasn't sufficient. She said we needed to see where risk free return was as competition to stock investing. Higher risk free return competes with stock investing, so P/Es will tend to be lower because investors shift toward less risky returns. Lower risk free rates of return (like for the last decade) allow for higher average P/Es without being over valued. She used short term interest rates as her "risk free rate of return" and I think she used the S&P500's P/E ratio.
I chose to use the Value Line P/E shown weekly in their Summary and Index section and the 13 Week Treasury Coupon rate. Some years ago, when interest rates dropped to zilch, I had the idea of incorporating the then current Consumer Price Index inflation rate as usually interest rates are slightly higher than core inflation. So, in the spreadsheet I added an "and if" statement that chose the higher of either interest rates or core inflation. It then adds that value to Value Line's P/E and comes up with what I call Relative Valuation (RV). It simply looks at whether valuations are appropriate relative to the "risk free" rate of return or core inflation.
I was delighted to find that my data from 1982 on closely confirmed Ms. Garzarelli's magic number of "20" as being neutral and that roughly 18 was bullish and 22 was bearish. It's been very good at calling out bullishness and not too bad on calling bearishness over the years.
Somewhere in Excel I found a way to colorize those graphs, so had it blend from green through yellow toward red - with the yellow band being right around the neutral "20" with green being down near the bullish territory and changing to red as the RV rose to around 22.
I hope you like it!!
AI
