Back to the present moment … We raised doubts earlier about “reflationary” efforts to boost the prices of impaired bank assets and the still falling home prices. We now raise the question: Are there limits to the equity market’s attempt to reclaim its past heights and restore its past glories, the one market still standing that isn’t directly under the government’s thumb? Lest we forget, the Shiller Graham P/E ratio, to which we referred at the outset, has been as high as 25 in 1901 and 1966 (excluding 1931, when earnings vanished, and 2000, when technology and the Internet were priced for eternity) and as low as 6.5 in 1921, ’32, and ’82. If the market marches upward (unrestrained by deteriorating corporate earnings to which it is ultimately tethered) to the optimistic heights of, say, 1966, then the S&P 500 could rise to 1380, a further gain of 480 points—or 50% above current levels. If, on the other hand, the current reflexive optimism proves misplaced, and the pendulum swings back toward the other extreme, the S&P could theoretically sink to 360, a decline of 540 points—or 60%. The end of reflation in equity prices would have profoundly negative effects on other asset markets, which, of late, have followed the lead of common stocks higher. If you haven’t reflected recently on the relevance of Pascal’s wager, now is the time to do so. (In a nutshell, and as it might be applied to the equity markets, it says that even if the probability of a decline to lower extremes is only 5%, the consequences are so disproportionately calamitous that all precautions should be taken to avoid it. ) Whether the S&P moves up or down roughly 500 points, the mathematical symmetry doesn’t begin to explain the intensely disproportionate influence each would have on investor, consumer, lender, and borrower sentiment. Even the current reading of 65.1 for the Consumer Sentiment Index also must be viewed in its historical context: It fluctuated between 100 and 110 from 1998 through 2000.
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