Welcome back to the trading week, friends and fellow traders. We're excited about bringing you today's edition because it's going to be somewhat interactive... we're going to be answering a reader's question. Before we get to it though, it's a perfect segue into a reminder we can't give you often enough - we read every single e-mail you guys (and gals) send us, and we respond when appropriate. If it's a response all of our readers will benefit from, we answer it right here in the newsletter. So, go ahead and send them in. Anyway, we got one question this weekend I'm willing to bet most of you were at least asking in the back of your minds. Bruce asks: "For a while I have wanted to ask about the P/E chart commentary. We always say that stocks compete with bonds for the available cash. I would think one would expect to see correlations between P/E and interest rates. You never mention it. Can you comment?" Thanks for the note Bruce. We'd love to address this topic. A preface is in order, though, before we get to the nitty gritty. Market theories are a dime a dozen. Most of them have a basis in truth, though few of them are as reliable as traders tend to treat them. Many of them fail to hold up all that well when put to the test, and some of them completely fail when the numbers are crunched. They all seem plausible on the surface though, and therefore continue to circulate as if indisputable, irrefutable facts. The low-interest-rates-support-high-P/E-ratios may be one such overestimated theory. To be clear, we don't disagree with the basic premise of the idea. If there's practically no money to be made with bonds (as is the case right now), and cheap money is allowing corporations to borrow for growth, then why not pay a premium for stocks? However, I think the idea of this cause-effect relationship oversimplifies how things truly work. I suspect valuations at any one point in time are driven by a dozen or more factors, most of which show little correlation with interest rates. Some of these factors are consumer sentiment, currency stability, momentum, commodity prices, and more. All of these forces could ultimately be linked back to bond yields (or vice versa), but in most cases that link is rather weak, and not a cause-effect one. There's more than enough emperical data to discount the low-rates/high-valuations theory too. One of my favorite recent looks at the correlation - or lack thereof - between rates and P/E ratios is this one from QVM Group. Now, I'll confess I see a loose, loose relationship on the scatter plot that QVM built to compare interest rates and P/E ratios. I still agree with their basic assessment, though, which broadly concluded there wasn't enough correlation to worry about [at least not in the swath of interest rates those guys were studying, though we have to assume their findings apply to most interest rates. The QVM team even plainly stated that P/E ratios appeared to have more to do with earnings growth expectations than rates.] . It was a point of view shared by AQR Capital Management's Clifford Asness several years ago, though his research is still applicable today. If you don't want to read that 33 page explanation, you can read Mark Hulbert's more recent and much shorter explanation of Asness' findings, which were basically that it did not make sense to adjust a P/E ratio (or tolerance for high P/E ratios) for interest rates or inflation. Rather, investors were better off just taking on a straight-forward point of view where high P/E ratios were bad and low P/E ratios were good. And, my eyeballed look-back at the S&P 500's trailing P/E in comparison to the 10-year treasury yield (TNX) only confirms what Asness and QVM concluded... the correlation between rates and P/E levels is minimal at best. I suppose the one edge my up-to-date look has on the Asness and QVM studies is that it's fresher, allowing us to compares rates and valuations all the way through today's date, factoring in our present situation (which is at least one bear market later). It's the visualization offered by my chart, however, which underscores the one key flaw with the whole premise of the theory - what's "normal" anymore? Low rates may well correlate with high P/E levels in a normal environment, but I don't think things have been normal since 1998. Every situation is different, and should be treated as such. So what's this got to do with Bruce's question about bonds and stocks competing for cash? We think it's still basically true, but the market and global economy being a complicated machine, we can't confirm the idea just using interest rate data. If you look really closely at this chart, in 1995, the S&P 500's trailing P/E was around 16.5 when interest rates on the 10-year treasury were above 6.0%. In 2006 the marketwide P/E level was around 16.5, and 10-year treasury rates are around 4.5%. Last year when the trailing P/E for the S&P 500 reached 16.5, 10-year yields were around 2.2%. So, we don't think there's a connection worth counting on here. Heck, as you can see on our chart, while bonds and stocks should be competing for investment dollars, even that theory hasn't held up too well of late... in the long run. Stocks have been rising for nearly five years now, but the 20-year treasury bond (TLT) is worth now more than it was then, which is the exact opposite of the way things were "supposed to be." In the short-term it seems we broadly see it work. For the long haul though, even the bonds-stocks inverse correlation hasn't been a great one in a long while. Point being, while it's good to learn from the past, we've always felt it's best to think critically and holistically about every market environment based on its unique nuances. No two are ever alike. And more directly to today's point, we can't trust interest rates as a barometer of the race between bonds and stocks. Thanks for the question Bruce. It was an idea worth digging into, and we hope everyone got something out of it. Now, let's talk about the near-term market after today's lack of action. Take It With a Grain of Salt This is going to be short and sweet today, mainly because there's not much to add to Friday's concerns that stocks have hit a major psychological ceiling. There was nothing about today's action to convince us otherwise. Yeah yeah.... the S&P 500 managed to close at a record high close of 2078.54. That's bullish, on the surface. Take a look at the volume for today though. This wasn't a majority opinion. I figured volume would be on the thin side all week long with the way the holiday fell right in the middle of the week. I didn't think it would be this weak already though. There's still some last minute buying and selling fund managers and proprietary traders need to get done to close out the year, and the number of days they can do so is dwindling fast. Anyway, in my scorebook I don't count today's modest bullishness as a break above the fairly established ceiling from the early December peak. It's close, but not quite there. And for what it's worth, the NASDAQ Composite didn't hurdle its prior peak either. I'm not even going to bother showing you that chart, because it wouldn't tell us anything new. Let's just agree we need to take things one day at a time this week, We know it's tough to stay in touch and keep reading the newsletter this time of year, but we encourage you to do so if at all possible. We're going to be doing some 2015 forecasting later this week and early next week, and you won't want to miss it. Hey by the way, are you still not done with all your holiday gift-giving shopping? If you're in a pinch or you just can't stand the thought of going out and fighting the crowd, here's an idea for you to give to a friend or loved one (one size fits all). Or better yet, how about you treat yourself to this gift we sure you're going to love?