Graph of the Week

Created: 2000-10-10
Last Modified: 20
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Graph of the Week: The Stock Market

J. Bradford DeLong

October 2000

  • Up until at least 1990, you could get a good gauge of the fundamental value of the stock market by taking a twenty-year moving average of the earnings of the companies in a stock index, and then multiplying them by 15.
  • Some years the actual value of the index would be above and some years it would be below this earnings-based benchmark (remember that on a log scale, a difference of +0.7 corresponds to a doubling; a difference of -0.7 corresponds to a halving).
  • But whenever the index was above the benchmark, it was (except in the late 1950s and early 1960s) going to come down; whenever the index was below the benchmark, it was going to come up.
  • Does this historical pattern still hold? Does the sharp rise in stock prices above the earnings-based benchmark in the 1990s signal that a large stock market crash is likely in the future?
  • It probably does.

Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax

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