Benjamin Borden's "Best Canadian Stocks"

We tend to get caught up in the day to day action and sometimes forget there are bigger, longer term trends going on in the background. Clearly a bigger trend going on right now is a general falling in average P/E ratios.

For example, if you look at a graph of the average S&P 500 P/E ratio since the year 2000, you can clearly see that it has been decreasing – from a high of around 40 to its present level around 20. If this continues (and probability suggests that it will) then we should expect this ratio to at least halve again before the “cycle” comes to a close in or around 2016 or 2017.

Now there are three ways a ratio can halve. Either the numerator (price) halves, the denominator (earnings) doubles, or there is some combination of change in both numerator and denominator.

The first way is a tough pill to swallow. It means that the S&P 500 would fall from it’s present perch at 1100 all the way down to 550. Get ready for another crash.

The second way is easier on the nerves. It means that average earnings double. However for most investors (with a bullish bias) this is also unappealing since it means the S&P 500 basically stagnates at the 1100 level for the next six to seven years. I believe this was called “stagflation” last time we saw these conditions in the 1970s.

The third case is the most interesting. It is possible that the S&P 500 actually increases as long as earnings increase at an even faster rate. If this were not a real economic recovery (merely a “bailout” recovery) this would probably be close to a hyper inflationary scenario. Conversely the S&P 500 could utterly collapse to below the 550 level if earnings continue to fall from where they are now. This would probably be a hyper deflationary scenario. I think it is possible to see both these outcomes swing in succession over the next six to seven years as the system basically pukes up all the debt it’s been forced to swallow.

Interestingly, in chaos theory when systems change from one state to another there is usually a period of hyperbolic swings increasing in intensity both above and below the old level of “normality” until a singularity point is reached.

Source: Tim Tyler, http://hexdome.com

Perhaps we are in store for a singularity event? Perhaps a completely new financial system at the end of the cycle? We shall see.