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Well just a few of my thoughts... please feel free to disagree/criticize...

On the one hand these "averages" can make sense, but ONLY when they are discussed in their proper context. We have to account for several factors in accurately gauging the P/E (and other ratios) of the S&P 500 Index.

You can look at such factors as why Standard & Poor's threw out many companies and replaced them with technology start-ups in the late 90's (incidentally, most of the ones that were thrown out of the index are up handily). Also, if you look at the index more carefully, in the year or so preceding the deflation most of the individual stocks actually declined in price. Because of how the index was calculated a small number of tech companies such as MSFT & CSCO were almost single handedly raising the index. Unfortunately the public began placing their confidence in the capital markets, and tracking the US economy, based on the S&P numbers and the DJIA; most economists use other (albeit more boring) indicators to measure economic health (such as manufacturing and inventory data). Ironically, close to half or a majority of S&P stocks are now rising; overall declines are still being driven by cap-weighted member companies.

You remember that P/E is composed of two pieces; Price of the stock AND earnings. Often the earnings portion is ignored and people focus solely on stock price. A small raw increase in earnings is enough to dramatically reduce the P/E ratio for a given company. A small raw decrease in earnings can easily double the P/E ratio. For many companies the P/E ratio is invalid because they are not receiving earnings. This can leave gaps in the equations used to calculate the P/E for the S&P.

Limitations with historical comparisons. The world economy is much different now than the other time periods mentioned. Technological, political, industrial, information delivery, and a host of other macroeconomic forces have dramatically changed, making it difficult to predict our current near term situation based on past cycles. This also being the case, I do not believe a recovery will take 10 years. It might take 10 years for Cisco or Yahoo! to recover and surpass their former heights, but i wouldn't project their doldrums to the US economy just because they have media magnetism.

I don't underestimate the power of the Fed, and the corrective measures used. I often think the public markets behave like spoiled brats. They forget that the separation of central banking activity from Wall St style trading is critical to the success of our economic system. One only has to look at our friends in Japan to see what happens when there are few boundaries between the central bank and the markets.

All this said I remain hopeful that the economy will begin a cautious recovery process sometime later this year. Many fundamentals are strong. Many of these so-called "earnings disappointments" are more the fault of analysts on Wall Street (the same group who recommended 'Buys' on the infamous dot-coms) who place historically high earnings growth expectations every quarter.

What I am more concerned about is the selling pressure that we will experience in the next 5-10 years as baby boomers begin redeeming their 401(k)s & IRAs(yes, i think many do actually want their investment+gains back!) Whether or not enought new workers will offset redemptions with new investments remains to be seen. I also find the levels of personal debt to be a new, disturbing factor (earlier generations went into debt for a house, now everyone seems to owe Visa/Mastercard---unwise).

I am continuing to invest every month in solid companies (as i define them). I feel lucky that I have not been burned yet, and have locked in gains where necessary. Even if the slowdown is longer than expected, I have several decades until retirement and will use the time to research, try new strategies, and learn from my successes and mistakes.


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