Market's P/E goes from 10 to 18 in five months
August 17, 2009
– Comments (4)
From the Bespoke Group:
"A P/E ratio rising from 10 to 18.35 is what happens when the S&P 500 rallies 50% (the P) while earnings (E) continue to decline.... [I]f the current bull is going to have any sustainability at all, earnings will have to start growing again. But for now, as evidenced by the skyrocketing P/E ratio, investors are paying up on the hopes of future earnings growth."
Expensive markets can get more expensive, but at some point, price matters.
Of course, the P/E is an interesting metric, since you can measure it different ways. Rule Your Retirement contributor Doug Short measures the P/E of the S&P 500 as 161.2 as of the end of July. That's definitely not cheap. Using the P/E10 (divide the real price of the S&P 500 by the 10-year average of earnings) yields 18.1, which is closer to Bespoke's number. As the chart below shows, that puts today's market in the second quintile for priciness.
It's a reasonable price to pay for a market with robust, sustainable earnings growth. On the other hand, it seems expensive for a market in the "new normal," when companies eek out better-than-expected earnings due to cost cutting rather than top-line growth.
Robert Brokamp is the senior advisor for The Motley Fool’s Rule Your Retirement service.
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