Not all market cycles are the same, but it is possible to note that certain trends in prices and certain behaviors of investors tend to recur.

During a bear market, in particular, an early stage of rejection is followed by a growing fear and by a more and more intense and extended selling, before a final mass capitulation.

Both the current trend than that of 2000-2003 followed the same pattern, as shown in this diagram.

Models downtrend

But what happens after the mass capitulation? In general, the minimum of market cycles are characterized by equity valuations often seen as convenient, but - at the same time - by a complete discouragement of potential investors.

In these cases, the daily flow of news becomes the true determinant of market, capable - as we saw again in recent sessions - to dictate pace and direction of prices.

It would be necessary to produce a sustained flow of positive news for a stock rally could take root and gain strength.

Unfortunately, this can not happen - I think - as long as banks and other major international financial institutions (most recently, the case of U.S. insurance giant AIG) will continue to announce serious financial difficulties and balances at risk.

Right now, if anything, it is likely that equity markets will try again to test new minimum (who asks me, I say - jokingly, but not too - that the minimum possible in an index or an action is without doubt the zero!).

The debate on whether today's stock market valuations are attractive or less attractive and is still in progress. Many market participants and economic commentators focus their attention on the very low level of Price/Earnings, as indisputable evidence of value.

However, one should ask: how reliable are the current estimate of profits at the base of the P/E ratio ?

If you look at the forward earning (profits expected in the next 12 months) the reliability seems to be very limited, especially in recent quarters. In addition, the estimates of analysts do not seem to be sufficiently reliable for making predictions, even considering that, at present, there is an almost total lack of consensus on the dynamics of expected earnings, an event which, however, is absolutely unusual (see chart).

Variability expected profits

You can find other measures of value that, even in previous recessions, have proven to be quite reliable, not in order to identify the exact points of minimum (and who could seriously say that!), but at least for indicate areas of relatively cheap acquisition, targeting, of course, an appropriate investment horizon.

One of these measures seems to be the P/E developed by Robert Shiller that, in the numerator, use the level of real price (i.e. adjusted for inflation) of the market index S&P500, and, in the denominator, the average of real profits of the previous 10 years.

The graph below brings together the indicator (inverted, i.e. in terms of E/P, real earnings yield) with the performance that the stock market has done in the following decade.

Shiller's P / E

From 1880 onwards, it seems clear that the indicator has a job if not perfect, at least good!

The Shiller's P/E was 16.3 in long-term average, and 19.3 in the last 50 years. In December 1999 was 44.2, at a record level that heralded a negative trend in the following decade, between 2000 and 2009 (!).

Today it is 13.4 which is the lowest level of the last 21 years, and for the first time since 1988 below 14. I leave to you any conclusion on the matter.

Regards.