Evidence Investing

 
 
People, Political Calculations has done it again...giving us one of the best pieces of information I have seen in a long time.  If you remember, they were the ones that turned us onto a new (and better) way to look at housing prices (read my post here).  

Well, this time they have graphed out the S&P 500 against the markets lagged (or trailing) year returns…which means we can actually calculate it going forward in real-time, by the way. 

Here it is:
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First we can make a few observations:

We can see the market ‘likes’ a set trajectory in ‘orderly’ times.  If you take out the Dot-Com Insanity (orange) and the recent Credit Crisis Debacle (red), you can see rather long term trends that persist for some time (months/years).  This directly shows us that when this ratio is getting severely out of whack, we need to be aware of severe mis-pricing.  

We also have some pretty clear, convincing, and succinct data supporting the belief that dividends (and earnings) DO in fact drive prices except when we have hysteria enter the market. 

Also, we can see that as of now (April, 2010) we are back to a place of ‘sanity,’ historically speaking.  To me this means that the no brainier deals in the markets of the past couple years are not very prevalent (i.e. we are not really undervalued anymore) and that we should be very wary of the continuance of a strong bull run (which would bring us significantly above the current spot on the graph).  

However, that’s not to say we know the new trajectory of the next trend on this graph…it could be steeper than previously.  But either way, if earnings and dividends continue, we should see a continued steady, slow, sane bull market.

Here's another version of the graph with a little trendline analysis to show you what I mean:
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I’ll give some space to the Political Calculations post: 

“[T]he conditions under which orderly growth can occur in the stock market will soon emerge. Those conditions require that the market's trailing year dividends per share grow in value over time as a basic requirement to allow orderly growth to occur.  At present, the data indicates the earliest that might occur approximately around June 2010.

If order does emerge in June 2010, the next six months will largely set the trajectory that we can reasonably expect stock prices to follow into the future. Knowing that trajectory will then allow us to project the future level of stock prices with a reasonable level of accuracy months, if not years, into the future - basically, as far as the available dividend futures data will allow us to see.”

Heady stuff! 
 


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