Yet another factor suggesting that the stock market has much farther to fall: inflation. In the past, high inflation has correlated to low P/Es, and vice versa (R-squared = 0.62). Today’s P/E is far higher than “normal” for our current rate of inflation. See the chart below from Merrill Lynch’s Richard Bernstein, posted by Vinny Catalano.
As the chart plainly shows, the current level sits well outside the sloped trend line and ominously close to the prior market peak levels of March 2000 and August 1987.
…Rich’s…primary point re inflation and P/E ratios is highly relevant and most timely. As investors face the last third of this woeful year, a look ahead into 2009 is fraught with danger. And despite the recent, and I would argue overdone, commodity price reprieve, one cannot exclude from that list a stagflationary environment that must find its way into valuation models.
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