Best of 2005: Our 100-Year Dow Chart Hits CNBC's 'Street Signs'
Any current analysis that solely uses the last 16 years of P/E data to conclude the market is undervalued is tainted
Editor's Note: This article was published on 11/8/2005
Good morning. Today I wanted to pen a quick note in regard to our long-term mega macro market theory. Yesterday afternoon one of the anchors of CNBC's "Street Signs," Ron Insana, did a segment on our 100-Year Dow Chart and ensuing market theory. (We will have a link on our website once we capture the video.)
For those of you who haven't read the theory or seen our chart please click here to print both. (http://www.tuttlemgmt.com/TAM/Dow-Jones-1900-2004.html)
However, for those of you who saw the piece, there are a few issues we'd like to clarify.
Ron did an exceptional job discussing the technical aspects behind the theory. Nevertheless, he neglected to mention the all-important fundamental underpinnings which coincide with the reasoning behind these technical patterns that have emerged over the last 100 years. Therefore I felt it apropos to follow-through and review this portion of the theory.
After reviewing the aforementioned article and chart you will notice the Price / Earnings multiple is set in place below the price action in the chart. You will also notice the main thesis is... "Excess market valuations, due to extreme price movement upward over extended periods, may take years to work off and allow earnings to catch up with prices." This is the fundamental portion not discussed in yesterday's segment on CNBC.
By looking at the chart you can plainly see how the price action - upward trends and consolidation periods - directly correlate to the direction of the P/E multiple. In other words, there has never been one instance in which the market has regained a mega-long-term upward trend without the P/E multiple first dropping below our stated "undervalued" level. This has proven over the last 100 years to be at or about a 10 P/E multiple for the S&P 500 - which currently remains above 17.
Consequently, our opinion differs from many pundits, analysts and money managers who believe the current level is undervalued. We believe this is a massive case of "straight line thinking;" which occurs when a trend has been set in place for an extremely long period of time and people forget, or have never experienced, the periods in which this wasn't the case.
For example, the P/E multiple has been above 14 since 1989 (almost 16-years) and hasn't bottomed below 10 since the last bull trend began in 1982. Straight-line-thinkers do not comprehend these valuations and that is precisely why we believe that any current analysis that solely uses the last 16 years of P/E data to conclude the market is undervalued is tainted.
Based on our theory the market is, and has been since mid-2000, in another (the 4th) macro consolidation period which will not be worked off until the market reaches these historic undervalued levels. However, let me be clear - we also believe the market will continue to give opportunities to invest (long and / or short) because the massive swings within these consolidation period channels can be as much as 30 - 40% from top to bottom.
Until next time...
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