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Amateur Investors Weekend Market Analysis (4/4/09)

http://www.amateur-investor.net/Weekend_Market_Analysis_April_4_09.htm

This week I plotted the Inflation Adjusted data for the S&P Composite (Blue Line) versus the Historical PE Ratio (Red line) going back to 1896. This data was calculated by Robert Shiller who is an Economics Professor at Yale. The first thing to notice in the chart below is that the S&P actually peaked in 2000 (point A) and not in 2007 based on Inflation Data. Thus the Bear Market actually began several years ago and not in 2007 which is portrayed by most media outlets.

Meanwhile another interesting thing about this chart has been the direct relationship between the PE Ratio and the Performance of the S&P Composite going all the way back to 1896. Furthermore since 1896 there have been 3 Cyclical Bear Markets prior to the one we are currently in now. In each prior Cyclical Bear Market notice the PE Ratio dropped below a reading of 8.0 (denoted by green line) before a bottom occurred (points A) which was eventually followed by another significant Bull Market lasting several years (points A to B). Currently the PE Ratio has dropped to around around 13 (point C) which is still above the historical 8.0 level that has led to significant Bear Market Lows in the past. If history does eventually repeat itself then the S&P may not make a Cyclical Bear Market bottom until the PE Ratio drops below the 8.0 level.



Of course the big question is how long will this current Cyclical Bear Market last as so far it has already been in place for 9 years based on the Inflation Adjusted data. A lot of parallels have been made with Japan's market so lets take a look at their chart. Notice the Nikkei had a big run in the 1980's which peaked in late 1989 near the 39000 level. Since then the Nikkei has been in a downward trend over the past 20 years and lost over 80% of its value as it has generally made a series of lower Highs (points H) and lower Lows (points L). It's debatable whether the United States problems are similar to or even worse than what Japan experienced in the 1990's with their Financial system. If the United States does follow a similar path to that of Japan then we are only about halfway through our current Cyclical Bear Market.



Furthermore if we compare the current Inflation Adjusted S&P Composite to the period from the 1960's and 1970s there are some similar patterns developing. First of all notice the similar ABC type corrective Wave structure between the two charts. Secondly also notice that the S&P Composite lost 58% from its peak in late 1968 to the bottom of Wave C in late 1974. Meanwhile from the peak in 2000 to the most recent bottom in March the drop was -59% which is nearly identical to what occurred from 1969 through 1974. Meanwhile notice after the 58% drop from 1969-1974 the S&P then rallied nearly 50% from 1975 through 1976 as it went through a corrective rally (points C to D). This was then followed by a 39% drop over the next 6 years from late 1976 through late 1982 before a bottom occurred (points D to E). Thus the Bear Market which began in late 1968 didn't bottom until late 1982 which was 14 years in length based on the Inflation Adjusted data. Considering that the current US Economy is in a recession that is potentially just as bad as that of the 1970's it's entirely possible the current Bear Market could last for several more years as we see a similar pattern evolve like occurred from the 1970's through the early 1980's. However as I mentioned above the S&P did rally nearly 50% after the 58% drop from 1968-1974 so it's certainly possible we are now seeing the development of a similar rally that will last several more months after the recent 59% drop.



Finally as far as the market for those that follow Elliott Waves the primary consensus is that the S&P 500 completed a 5 Wave pattern to the downside as it bottomed on 3/6/09 at 667 which is now being followed by an ABC type corrective type rally. Thus far the S&P 500 has gained 26% in 4 weeks as the "A" Wave up has developed. Once the "A" Wave peaks then this will be followed by a "B" Wave pullback before the "C" Wave up occurs. Some upside targets for the S&P 500 based on longer term Retracement Levels and EMA's range from 960 to 1014. The 960 area corresponds to the S&P 500's 40 Week EMA (green line) while the 1014 level coincides with its 52 Week EMA (blue line) and 38.2% Retracement Level calculated from the October 2007 high to the March 2009 low. I expect at some point in the coming months once of these levels will eventually be reached.



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