Noticed that the time of my posts has been 1 hour off (in the future), I just corrected that.

We are still waiting for Q4/09 earnings reports to come in, only 71% have reported so far. But based on current estimates it is likely that we’re seeing P/E ratios return to normal after having spiked to levels over 100 for several months. As of now, annualized (12-month) earnings have rebounded back to about 50, which brought the P/E ratio back to about 22. Time will tell if those high earnings are sustainable, I personally believe they aren’t and we’ll see another increase in the P/E ratio, and eventually a fall in price balancing that rise. Below are the charts that incorporate the 4th quarter estimates.

Price and P/E Ratio Chart:

Price and Earnings Chart:

Found this great chart on Nathan’s Economic Edge (click on the chart to see the full size version). Even though it’s very funny, I’m certain that every trader has gone through any one of those emotions before.  

The S&P 500 P/E ratio remains at lofty levels above 130. I don’t see how it can go higher from here and believe a top is forming in the 130..150 range, followed by an inevitable sharp drop to historically reasonable values. P/E ratio, earnings, and price for the October 2009 have changed very little from September:

S&P 500 Price 10/31/09: 1036.19

S&P 500 P/E Ratio 10/09: 137.98

S&P 500 Earnings 10/09 (calculated from price and P/E): 7.51

Price and P/E Ratio Chart:

Price and Earnings Chart:

(Note: the latest version of these charts is from now on available on our charts page.)

The Price to Earnings ratio for the S&P 500 remains near record highs. Standard & Poor’s recently released the data for September, and reported a P/E ratio of 140.76. P/E levels of this magnitude simply cannot persist for long, and strongly call for an adjustment in price to match the low earnings. See updated charts for price, earnings, and P/E ratio of the S&P 500 below, and click here for more information on the source for this data in my post from last month.

I created the following charts after hearing about the insane S&P 500 P/E ratios of 143 in July and 129 in August. I needed to verify those numbers for myself, and came across several sources reporting the P/E ratio of the S&P 500 as only 18 in August. Which one is correct?

Using Standard & Poor’s own website, the P/E ratio for August is indeed 129.19. I also found historical data on the S&P 500 price, dividends, earnings, and P/E ratio on Robert J. Shiller’s website. He calculates the S&P 500 P/E ratio as the ratio of the S&P 500 price level and a 10-year moving average of the earnings data. The result is a P/E ratio of 18 for August. A 10-year moving average really smoothes out the P/E ratio and the last few months of 100+ P/E ratio values are lost in the average. For the purpose of evaluating present value of the S&P 500 a 10-year moving average really isn’t adequate, and instantaneous (monthly) values should be used as reported by Standard & Poor’s.

The charts below really speak for themselves. Looking at the wide gap between current S&P 500 price levels of about 1000 and earnings around 7 (these are earnings levels last seen in the ’70s!), there is no question that the markets are still heavily overvalued, and a second downleg is highly likely. The markets are still in denial, and P/E ratios of more than 100 simply cannot persist for much longer.

Historically, P/E ratios have always moved in long waves spanning several decades, and at the end of bear markets they always return to values below 10 (see the P/E ratio chart for 1900-1950 at the bottom of this post). It is unlikely that we’ll see a quick recovery of S&P 500 earnings, so the only logical conclusion left is a reduction of the S&P 500 price to levels in the 100..200’s. I don’t think this will happen within a year, but it could happen over the course of 10 or 20 years. We may see a gradual decline in price while earnings remain depressed.

(Note: I will post updates on these charts monthly: click here. Or you can find the most recent chart on our free charts page.)

I expanded my charts page. The following charts were added:

• USDJPY Hourly
• EURJPY Hourly
• US Dollar Index Hourly
• US Dollar Index Daily
• S&P 500 Hourly
• S&P 500 Daily
• Dow Jones Industrial Average Hourly
• Dow Jones Industrial Average Daily
• Gold Houry
• Gold Daily
• Silver Hourly
• Silver Daily
• GDX Hourly
• GDX Daily
• Federal Funds Rate Daily
• 10-Year Treasury Rate Daily
• 30-Year Conventional Mortgage Rate
• M1 Money Stock
• M2 Money Stock
• Reserve Balances with Federal Reserve Banks
• Federal Government Debt
• Total Consumer Credit Outstanding
• GDP
• CPI
• PPI
• Trade Balance
• Imports of Goods
• Exports of Goods
• Nonfarm Payrolls
• Unemployment Rate
• Business Inventory
• Retail and Food Services Sales
• University of Michigan Consumer Sentiment
• Spot Oil Price

I also added three dedicated chart pages for the currency pairs EURUSD, USDJPY, and EURJPY. They can be accessed by clicking on the title above each of those charts on the main chart page.

Go check it out: http://www.kangarootail.com/charts/

I’ve been looking at the big picture across all major markets lately, and have arrived at a turn of my long term view. I believe that we’ll remain in a deflationary environment for several years to come, at least two but likely more, and that inflation will only set in after the deflationary debt destruction has run its course. Credit is contracting faster than money supply is increasing, despite the efforts of the Fed to pump trillions into the system. The “financial holes” generated by credit that is marked-to-market (e.g. mortgages gone upside down by a 40% collapse of housing prices) are much larger and are growing much faster than the ability of the Fed to plug them. The trillions of dollars the Fed is pumping into banks is sorely needed to keep the banks alive, and even after several bailouts of mind boggling proportions the banks are in no position to lend, to direct the money where it’s needed to get us out of this mess (e.g. to pay down mortgages, credit card balances, etc.) Thanks to our fractional reserve fiat money system, the amount of credit in our economy dwarfs the amount of “real” money (cash and bank reserves), and it is the collapse of this giant credit bubble that soaks up any available cash out of the system as fast as it is printed or injected into the economy. The current state of our economy can be likened to a giant margin call hitting one over-leveraged investor, the Federal Reserve.

It is this situation coupled with recent economic events and developments and supported by economic data and chart patterns that have led me to the following conclusions of what I think will unfold over the next 3-6 months:

1. The dollar has made a major bottom and is turning up for a bull rally that may well last over a year. The pattern on the EURUSD dailies chart looks very similar to the pattern of last summer, just before the collapse of the Euro in August. The recent upleg does not look healthy at all, but tired and vulnerable to a break to the downside. The next few weeks will tell whether we’ve seen a top or not, it is possible we see an exhaustion rally first before the downside gathers momentum, but I believe it is more likely that this is it, that the dollar will move up from here.

2. The stock market is very close to a peak, and will turn down very soon to retest its March ‘09 low. Consumer sentiment came in lower than expected, banks keep failing (almost 80 banks have failed so far this year), the FDIC is almost out of money, banks keep lying about their balance sheets and refuse to mark their impaired loans to market just to stay alive, and the government is not very efficient in “trying to help”. Looking at a daily chart of the S&P500, we have hit major Fibonacci resistance near 1000, and the RSI has just turned down from overbought. The last leg of this rally looks weak and is running out of steam. The S&P500’s P/E ratio stands at a dizzying record high of 140. I believe we’re about to see a major collapse, possibly triggered by a big item of bad news, or the market will simply fall of its own weight.

3. Gold will not exceed $1000/oz and will turn down as the dollar goes up. Gold stocks will follow. I think gold will not do well in a continued deflationary environment. It has done well earlier this year in an enviroment of risk aversion, and in expectation of inflation when the government announced bailout after bailout, but I believe we’re headed into a market where the need for dollars will outstrip gold’s allure as a safe haven commodity. I think there’s a fair chance we’re seeing a return to $700/oz by the end of this year.

4. The real estate market has only made a seasonal high and will turn down. I live in California, and closely follow the California real estate market. The recent upturn in prices does not make the long term chart look like it has bottomed. It looks very much like a seasonal bump, and it is very likely that we have at least 2-3 years of falling prices ahead of us. Looking at the chart below it is clear that real estate markets don’t make V-bottoms, and I don’t see how this market can be any different. If anything, we’ll see a prolonged bottom since banks are unwilling or unable to cut their losses fast. Instead they put off foreclosures, NOD filings, and drag out short sales. I strongly believe that housing prices will stay depressed despite a record high affordability index. The bottom line is that people are simply out of money, cash strapped, and need every dollar they can get their hands on to deal with their debt. Very few have saved up the down payment needed to qualify for a loan today.

All of these events are coupled, and chances are that either all of them come true, or none. We’ll know very soon.

Strong rebound that started in Europe and picked up in early New York has now hit 1.42 and is overbought with RSI at 77. Early afternoon NY time is often a time strong rallies end, and I expect one more push above 1.42 before either a minor pullback or a leveling out and consolidation at the current levels in Asia. Would not be surprised to see another pullback to the daily EMA10 (1.4050ish) before 1.43 is challenged.

My long that I entered two days ago 1.4110 is in play and I lowered my target slightly to 1.4220.

Strong rally sliced through several strong resistances and took us back all the way to 1.41. My long target was hit for a nice profit of 142 points, which felt good after the 131 point loss I took two days ago.

On the dailies, it looks like we got a bottom in place at 1.3747. Now heavily overbought, we’re approaching strong resistance at 1.4125, and I expect this level to hold, given that the RSI is already at 80. That, and the fact that this rally started after a downleg without any major upward consolidation phase, suggests a strong pullback will happen first before this upmove continues. I do expect another strong upleg following this one as soon as RSI has corrected back to neutral (45..50).

In the short term, I think a decline to the 50% Fibo at 1.3962 is the most likely scenario. I went short at 1.4095, stop tight at 1.4150, and target is 1.3970.

Support: 1.4013 Fibo62, HRsst   1.3962 Fibo50   1.3912 Fibo38, HSpptRsst

Resistance: 1.4125 SpptRsst   1.4177 H-6-11   1.4235 Rsst

RSI: Hrly: heavily o/b, Dly: neutral

Hourly Chart:

Daily Chart: