History Being Repeated

In our last post, we began the conversation around market corrections.  In this post, we continue this analysis to see that we are seeing history being repeated.

For our next piece of data to evaluate, we turn to the S&P 500 90-year earnings chart.   For those wondering what is EPS (Earnings per share), it is:

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability. It is common for a company to report EPS that is adjusted for extraordinary items and potential share dilution.  The higher a company’s EPS, the more profitable it is considered to be.

Looking at the chart of S&P 500 EPS: (EPS = orange line, S&P value = blue line)

If you stare deeply enough, you may notice that whenever EPS(orange) crosses over the S&P line(blue), a correction or crash is likely.  In December of 2019 we had ANOTHER cross over where the EPS line is now below the S&P line.  However, you may mention that the S&P continues to go up, even after this event in December 2019.  This causes us to dig further.

However, we can turn to Investopedia for more details around Stock Market crashes.

Understanding CAPE and Stock Market Crashes

The price-to-earnings ratio, or P/E, is one of the most important measures of the current value of a stock. It is the current price of the stock compared to its earnings per share. Investors look at two versions of it, one comparing the stock’s price to its earnings over the past 12 months and a second comparing its price to its projected earnings for the next 12 months.

The average stock has a P/E ratio of about 15x, or 15 times greater than its earnings. The higher the number, the pricier the stock looks. The lower the number, the better a buy it appears to be.

The cyclically-adjusted price-to-earnings ratio, or CAPE, is a variation on this formula, which is why it’s sometimes called the Schiller P/E ratio or P/E 10. It compares a stock’s current price to its real earnings per share averaged over the past 10 years and adjusted for inflation. That smooths out the gyrations of the market, presumably giving a more realistic view of whether a stock is over-priced or under-valued given its real performance over time.

The CAPE ratio can be extended to the markets as a whole, or to a reasonable representation of the markets such as the S&P 500 Index. Tracking the number through history, you can see that the number hit a then-record 30 just before the Great Crash of 1929, after which it fell to single digits. It climbed to a record near 45 just before the dot-com bust of 2000 before falling to 15. By the end of 2020, it stood at 33.82.

We currently sit at 37.42 Shiller PE Ratio! On the chart, you can see Black Tuesday (Great Depression) and Black Monday (1987!!!!).  The Dot Com Bubble and the 2008 Housing crisis are pretty evident as well, even though they aren’t marked. The fact we are WAY ABOVE 1987 AND 2008 should be sending red flags everywhere!  Also, more signs we are seeing history being repeated.

Lastly, we can look at CPI (Consumer Price Index).  This was recently announced and we have seen a 5% increase over the last year.  This is bad news for everybody and is likely an underestimate of the true inflation number. We can look at a historical chart below:

We can also look at the news release:

So, what does that all mean?  To me, it implies that we really are seeing history being repeated.  We have seen a longer than usual bull run on the US stock market.  We are seeing inflation rising at astonishing rates.  We have seen the quadrupling of the amount of US dollars in circulation as we discussed in prior posts.  Frankly, we all need to be looking at the data and making decisions wisely to prepare for the worst case scenario, a protracted and lengthy financial correction.

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