Rule of 20 P/E Ratio

It seems to us that nobody is playing this game (investing game) except traders, and the ups and downs of the market are swaying with the oscillators.  You see below how in the 2013 market, each time the McClellan Oscillator has come under the -50 line, the stock market has rallied.  It actually moved to its most oversold posture on last week's decline.  


But the tops have only moved the McClellan Oscillator to a lukewarm overbought posture of +50.  These oscillators are pure-and-simple trading gauges, except in the rare experiences that the oversold conditions of the 21-Day Oscillator moves down to the -100 zone, but...we always keep our eyes open on these conditions.

In the next chart below, you can see that the recent move up in the forward P/E (valuation based on the next 12 months' expected earnings) has now reached levels that have only been exceeded (for the last 35 years) in that 1996 to 2005 environment.  


Our Rule of 20 tells us that they are still too low, based on the inflation outlook.  You can see from the orange line in the chart above that the Rule of 20 has been calling for a season of higher P/E ratios since the end of the 1987 correction on a perfect upward trendline.  This has been a result of lower inflation, higher productivity and lower interest rates.


Don Hays

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