10-YEAR MOVING AVERAGE VS EXPONENTIAL REGRESSION

The following charts are based on Professor Robert J. Shiller's online data base. While Professor Shiller uses a 10-year moving average of inflation adjusted S&P 500 composite earnings to calculate the S&P 500 price earnings ratio, I recommend using the exponential regression of inflation adjusted S&P 500 composite earnings and the inflation adjusted earnings from Cowles and Associates (Common Stock Indexes) for the last 138 years to calculate the S&P 500 P/E (i.e. an exponential P/E).

A 10-year moving average of earnings was used by Benjamin Graham when calculating the P/E ratio for individual companies. While a 10-year moving average can do a good job smoothing out a company's short-term earnings fluctuations it may not be up to the task when dealing with abnormally high or low stock market index earnings over extended periods of time.

Because Professor Shiller's data is inflation adjusted the exponential P/E will react to inflationary trends. Rising inflation will cause the exponential earnings trend line to rise, which will result in the current exponential P/E being adjusted downwards. Historic exponential P/E will remain relatively stable due also to the upward adjustment of the past S&P 500 index values.

While the vast majority of investors find the scenario of a S&P 500 P/E of 10 extremely unlikely (no matter what earnings measurement one uses), I believe that if a given outcome is possible, even if highly improbable, it must be taken into account. Please keep in mind that given high inflation, the S&P 500 does not need to fall to 499 to hit an exponential P/E of 10 (based on July 3, 2009 exponential earnings of $49.99). A rise in the inflation adjusted exponential earnings trend line could push an S&P 500 exponential P/E low of 10 to an S&P 500 value of 600, 700 or more.

METHODOLOGY

The S&P 500 exponential earnings will change over time due to changes in future reported earnings, adjustments for inflation and compounding. I plan to update the S&P 500 exponential earnings trend line on a quarterly basis to reflect current reported earnings and inflation. The current S&P 500 exponential earnings and exponential P/E will be published on Friday of each week.

Professor Shiller's S&P 500 monthly values are based on a monthly average of daily closing values. Because I wish this web site to show the current performance of the market, I plan to update the web site on a weekly basis using the most recent weekly S&P 500 closing value (closing value of the last business day of the week) with the prior monthly values based on Professor Shiller's monthly average of daily closing values. Between weekly updates, in order to obtain the current S&P 500 exponential P/E, the current S&P 500 value can be divided by the exponential earnings found in the table at the top of this web page.

For illustrative purposes I have substituted the S&P 500 closing low of 676.53 on Monday, March 9, 2009 for the March 2009 monthly average value and also substituted the October 9, 2002 closing low of 776.76 for the October 2002 monthly average value. Since it is rather hard to see the current S&P 500 value and exponential P/E values on the 1871 - 2012 charts I am including charts for 1982 - 2012.