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Real Time Insight

At least once a quarter, it's good to review the hard data on P/E ratios to see where we're at on the big "fear vs. greed" scale.

Before I show you some revealing charts using the Shiller "Cyclically-Adjusted P/E" or CAPE, let's do some simple and intuitive math about where we are.

The trailing 12-month earnings for the S&P 500 are about $90 through May. With yesterday's index close of 1640, that gives us a TTM P/E of 18.22.

Now, from a very simple common sense point view, most investors would regard the S&P cheap at 10X and "dear" at 20X. This is supported by the long-term historical average of 15X. We are close to dear for TTM EPS.

What's the forward view look like? Consensus estimates for this year put S&P EPS at about $108.50. That means we are trading on a 15 multiple with 3 quarters of earnings yet to be revealed. That's a little more palatable.

And it gets even juicier when you look at 2014 estimates of $115 for the "top-down" view (Wall Street economist and strategist projections) and $121.50 for the "bottom-up" view (aggregated company estimates).

These 2014 estimates value the market at only 14.25X and 13.5X, respectively.

Okay, now for the more sobering views from economists and quants who favor "smoothing out" historical earnings to adjust for business cycles and inflation. And these sober folks also don't want to get anywhere near forward estimates, considering them useless to guide us in valuing the market based on historical trends.

John Hussman is a big fan of this and his work is worth reading. But his analytical work has kept him out of stocks since 2009. Today, let's hear from Doug Short, a quant with an apt last name for his skeptical view of valuations here.

Benjamin Graham actually came up with the idea of taking a ten-year average of earnings, and it was popularized by Yale professor Robert Shiller in his 2000 book "Irrational Exuberance." The Shiller or "CAPE" is also often called the P/E10. All these thinkers regard a 10-year average of earnings as more "real" and thus inflation and cycle-adjusted.

By Doug Short's calculation, the P/E10 is currently at 23.5. Here are his charts which put this in historical perspective...

So, what do you think? Is the P/E10 meaningful, or are stocks still cheap based on forward estimates that you find reliable?

Or do you think they are just "fairly" valued based on sustainable earnings trends?

And the broader question: Do you think the market needs to respect its "over-valuation" based on P/E10 and is therefore due for a big mean (and nasty) reversion sometime in the next few years?


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