July 18, 1997

The S&P 500 index increased at an average real rate of 1.6% per quarter from 1988 to 1994. Since then, the real appreciation has accelerated to average 6.4% per quarter, as indicated in the first figure. We attribute the acceleration in large part to the midterm Republican Congressional victory and to Alan Greenspan's commitment to a domestic price rule monetary policy. Regardless of the cause, one fact is irrefutable, the run up in prices has resulted in what some investors consider to be a fairly high price-to-earnings ratio. Historically, an above average P/E ratio has reverted to its long-run mean.

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