Next S&P 500 bottom? Maybe 1468

Summary

- The S&P 500 index (SP500) has been recently dropping.

- The Shiller (PE10) has also been dropping.

- We can estimate the bottom of the SP500 based on historical PE10 values.

- This estimated SP500 bottom is 1468.94.

Faster moving averages chase slower ones

The picture below shows two charts prepared with Yahoo Finance (). The top chart shows the SP500 together with its 5-month moving average. The bottom chart also includes the 10-month moving average.

This picture illustrates one import point: faster moving averages usually “chase” slower ones. This is, of course, a figure of speech.

The fastest moving average of all is the index itself; e.g., the 1-month moving average of the index measured on a 1-month basis.

The corresponding 5-month moving average is slower, and the 10-month is even slower.

The slowest moving average of all is the average (or mean) of the index over its entire history.

History tells us that, as the gap between the fastest and slowest moving averages increases, so does the likelihood that they will converge with a “vengeance” – at a wide angle.

The Shiller PE ratio

The Shiller PE ratio (PE10) () is based on average inflation-adjusted earnings from the previous 10 years. As such it removes the “contamination” of inflation and other factors that artificially influence the denominator of the standard PE ratio. This is why we use it here.

In October 2018 the PE10 reached 33.01, the second highest peak in its history. Since then it has been going down, presumably chasing a moving average. If it were to bottom, history suggests that it would go down to around the slowest moving average: its historical average of 16.58 (approximately, in October 2018).

The SP500 bottom

The PE10 going from 33.01 to 16.58 would be a drop of 49.77 percent.

The SP500 was 2924.59 in October 2018. A drop of 49.77 percent would take it to 1468.94.