Is the Cyclical Bull Market Over?

Is the Cyclical Bull Market, which began in March of 2009, almost over?

In my January post I presented a “Market Psychology” perspective of the current market where I pointed out that individual investors were finally beginning to re-enter the stock market in measurable numbers. Unfortunately “John Q. Public” is normally the last to arrive before a significant correction.

In my February post I focused on the “Technical” aspects of the current market. The long term chart I presented suggested that the Secular Bear Market which began in 2001 may not be over yet. If true, the current cyclical bull market will not continue much higher without changing the long term thesis.

In this post I want to present a “Fundamental” analysis of the current market. Fundamentalists want to know if the market is expensive, priced right, or too cheap. Their focus is on corporate earnings relative to price. To measure this relationship they calculate the “price earnings” ratio by dividing price by earnings.

The thing to remember is that the larger the PE ratio the more expensive the stock or market at large and vice versa.

The chart below was prepared from data provided by Dr. Robert Shiller, Professor of Economics at Yale University using his Cyclically Adjusted Price Earnings (CAPE) Ratio for the S&P 500 dating back to 1900.

The important thing to observe from this somewhat intimidating chart is the following:

  1. The historic average, and considered “fair value” CAPE Ratio is 14.
  2. The current CAPE Ratio is 22.91 or 65% higher than fair value.
  3. Based on market history many analysts suspect the CAPE ratio will drop below 7 before this Secular Bear Cycle is complete.

Click to Enlarge Chart

Dr. Robert Shiller, Professor of Economics at Yale University, CAPE Index
Dr. Robert Shiller, Professor of Economics at Yale University, CAPE Index

Chart courtesy of

The smaller chart beneath the CAPE Ratio Chart represents the Cyclically adjusted Earnings half of the CAPE equation. The chart ends with S&P 500 earnings in September 2012 calculated at 85.35 dropping from 88.27 in February 2012.

As you can see, earnings have been falling for the past year yet the S&P 500 continues to climb towards it’s record high. From a fundamental perspective one of two things must happen. Stock prices must fall to catch up to earnings or earnings must rise to catch up to prices.

What ultimately will happen in the future is anyone’s guess. As an investor all we can do assess the risk based on the evidence at hand. Markets can react irrationally for quit some time but eventually the pendulum will begin swinging the other way.