Stock Market Assesment - Part 1

Here's a look at 140 years of the real (inflation adjusted) S&P 500, data courtesy of Robert Shiller's Irrational Exuberance web site.  The graph is the natural logarithm of the monthly data.

The pink line is the best fit for the entire data set.  The dark purple line is the extrapolated best fit for data through 1994 only.  Since 1995, the stock advance has been so extreme that there is now about a third of a log unit gap between the two lines.   To overemphasize the point, upward motion in the index since 1995 has been so extreme, it caused a dramatic shift in a best fit line based on quarterly data going back to 1871!

In 1995, the S&P 500 average launched like a rocket off the pink trend line.  All was well until 2000.  Then a jagged decline began, and though the fall into the 2003 bottom was steep and hard, it stopped well above the trend line.  Not so the 2007 collapse, which took a quick peek below trend in the spring of 2009.

Of course, that's all based on the trend line for the entire set.  Consider the extreme altitude above the dark purple line.  Despite the steep drops, the index never came close to it.

Here's the same data, with 25 year standard deviation bands above and below the full data set (pink) trend line.

About 100 years ago, the index spent a long stretch mostly above the upper standard deviation line. After that, except for some brief spikes in 1929 and 1937, it fell to below the trend line (either one) for almost 40 years.  In the 60's the index pushed up against the upper standard deviation line, but never pierced it.   That was followed by a steep decline that lasted about 15 years.

Now, the index has been bouncing off the stratosphere for a decade, and popped through the upper standard deviation line twice - the first time for a six year stint.  And that's after spending nine straight years above the best fit line through 1994.

Update:

Taking note of how the slope of the best fit line was affected by the last 15 years, here is a graph of the slope over time, viewed two ways.  The blue line starts with the slope from 1870 to 1930, and increases the size of the data set with each passing year.  The pink line sweeps a 60 year envelope across the data set.  Make of it what you will.  But it looks like we're in a down phase, from an extreme high. {End Update.}

Where do we go from here?   Well - take a guess.  I don't have a crystal ball.  But it looks to me that a phase spent above the best fit line leads to a phase spent below it, and that time spent above the upper standard deviation line leads to a long steep decline.

Stay tuned.  In upcoming posts, we'll look at earnings and the P/E ratio.

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