- decline 45% to 85% from its 2022 high
- not exceed 1/4/2022 all-time high until 2030, at the earliest
The January 4th high prediction is based on the findings from my empirical research of the S&P 500’s Basic and Shiller PE multiples at the index’s extreme cyclical and secular highs from 1929 to 2022. The research resulted in the following discoveries and the development of the first ever PE multiple which adjusts for inflation and deflation:
- Discovery that the Basic PE multiple, taught by business schools since the 19th Century, is worthless for determining whether or not the S&P 500 is undervalued or overvalued. The Basic’s average multiple of 19.5 at the S&P 500’s extreme cyclical and secular lows was less than one point from the Basic’s 20.4 average PE multiple at the index’s extreme highs from 1921 to 2022. The Basic PE is calculated by dividing the share price or index by the TTM (trailing 12 months) earnings of the share price or index.
- Development of the AlphaTack PE (AT/PE), a proprietary PE multiple. AT/PE is the only multiple which is adjusted for inflation and deflation.
- Discovery that AT/PE and Shiller second highest and Basic’s third highest PE multiples since 1929 occurred on 1/4/2022. The table below depicts the S&P 500’s five highest ATPE, Basic and Shiller PE multiples at the index’s extreme highs from 1929 to 2022. The highest multiples ever computed for the three occurred on March 24, 2000.
- Discovery of the negative PE multiple. The AT/PE’s development enabled a negative PE to be calculated for the first time in history. The AT/PE’s 10 lowest monthly PE multiples from 1880 to 2022, which ranged from -4.41 to -8.35, all occurred during the 1909-1921 and 1929-1942 secular bears. The S&P 500, from its lowest and negative PEs in 1921 and 1932, increased by a minimum of 300% within 5 and 8 years respectively.
The parameters to identify the S&P 500’s extreme cyclical and secular highs and lows which qualified for the empirical research of the S&P 500’s PEs are as follows:
- Minimum 36% increase from an extreme low to an extreme high
- Minimum 28% decrease from an extreme high to an extreme low
The two charts below depict all of the S&P 500’s qualifying extreme highs and lows from 1928 to 2022. A list of all of the qualifying highs and lows for the S&P 500 from 1928 to 2022 is available at AlphaTack.com.
Discovering that the basic PE multiple is of little value was not a surprise. I had concluded back in 2002, from my post mortem of bankrupt Enron’s Financial Statements, that EPS (earnings per share) was an unreliable indicator for determining the value of a share or the financial condition of a company. See, “High Concept: How to Spot an Enron”, Inc. Magazine November 2002.
Yale Economics Professor and Nobel Laureate Robert Shiller also had concluded that the basic PE was insufficient. He created the Shiller PE for the S&P 500, which is more reliable than the Basic PE. However, after analyzing Shiller’s PE, a deficiency was discovered. The Shiller PE multiple does not adjust the multiple for inflation or deflation.
Shiller, instead of adjusting the PE multiple, adjusts a business’ earnings, the PE’s divisor for inflation or deflation. The adjusted earnings are then utilized to compute the multiple. The problem with adjusting the earnings up or down is that the impact on a share multiple is nominal. For example, $1.00 per share of earnings in a 10% inflation or deflation environment is adjusted to either $0.90 or $1.10 by Shiller. Thus, Shiller’s method for calculating a multiple suppresses PE multiple volatility.
The growth rates and the earnings, revenue and cash flow multiples which are utilized to value a business must be adjusted for inflation or deflation. In an economy with 0% inflation/deflation, a business growing at 10% would have a 10% growth rate. For a business growing by 10% in an economy which has 5% inflation the net growth rate for the business would be 5%. It’s because half of a business’ growth would be attributed to price increases.
The unadjusted or Basic PE multiple of a business has historically been based on an old Wall Street rule of thumb which says that a business’ fair PE multiple is equivalent to its earnings growth rate. Under the rule, which does not adjust for inflation or deflation, the multiple for a business growing at 10%, would be 10. However, for a PE multiple to be precise, it must be adjusted for inflation or deflation.
Another rule, the Rule of 20, was developed in the 1970s to adjust for inflation or deflation. Under the rule, the inflation rate is added to and the deflation rate is subtracted from the basic PE. See also Yahoo Finance: “You’re probably using P/E ratios incorrectly”. For example, if the shares of a company growing at 10% trade at a PE multiple of 10 in an economy which has 5% inflation, the net PE multiple would be 15. It’s because half (5%) of the company’s 10% earnings growth is derived by inflation and not organic growth. Thus, the rate of inflation must be added to the PE multiple for a company or an index. Conversely, a business, with a PE of 5 growing at 5% in an economy with 10% deflation, the rule equivalent net PE multiple would be -5. The multiple would be negative since the deflation rate is subtracted to calculate the actual multiple for the shares.
The conclusion, from my research of the S&P 500’s Basic and Shiller PE multiples and consumer price index dating back to 1872, was periods of high consumer price index (CPI) volatility (sustained periods of inflation followed by sustained periods of deflation) highly correlated with severe stock market volatility. Since neither of the multiples addressed the inflation/deflation issue, the AlphaTack PE multiple (AT/PE) was developed to fill the need. The AT/PE utilizes the average of S&P 500’s earnings for its prior 10 years to compute its base multiple. The percentage increase in the monthly CPI or inflation is then added to the AlphaTack core PE to compute the AT/PE. The percentage decline in monthly CPI or deflation is subtracted from the AlphaTack core PE. The AT/PE is the only PE which adjusts the PE multiple for inflation or deflation.
The table below contains the average highs and lows for the AT/PE, Shiller and Basic PE multiples at the S&P 500’s qualifying extreme lows and highs from 1921 to 2022.
|Video No.||Secular Bear Market on the Horizon Videos||Run Time|
|N/A||What is the difference between a secular bear and a cyclical bear?||4:35|
|N/A||Why the minimum duration for a secular bear is 8 years||1:15|
|N/A||Secular bull investing strategies do not work during a secular bear market||2:12|
|N/A||Why the worst performing stocks during a secular bear were always the best performers of prior secular bull||1:36|
|N/A||Proven Secular Bear investing strategies||10:28|
|N/A||AlphaTack, Secular Bear Investments Lifeboat||2:03|
Finally, my “Acceleration to Digital Economy; why Stock Indices quickly reached new all-time highs after 2020 crash” article is highly recommended. It provides the rationale for why the 2020 crash proved to be a dip buying opportunity which capitalized on the leading digital and tech companies including Apple, Amazon, Facebook, Google, Microsoft and Netflix being undervalued. However, those who deployed the dip buying or continue to hold long term strategies during 2018 and 2020 periods of volatility and who believe that the S&P 500 will quickly recover back its January 2022 high are in for a rude awakening.