A version of this article first appeared on TKer.co
It’s not hard to argue that stock market .
According to , the (P/E) multiple for the S&P 500 is 22.9x, which is significantly above its 10-year average of 18.6x.
So, what are we supposed to do with this information?
Some people may be inclined to dial back their exposure to stocks under the assumption that prices are due for a correction. Some might sell everything. Some might even short the market.
The problem is that valuation ratios aren’t particularly reliable predictors of where prices are headed. Forward P/Es about what prices will do over the next 12 months. P/E ratios seem to provide a stronger signal on long-term returns, but .
We don’t have to go back too far to see another instance when the forward P/E was this high. In 2020, this as stock prices rebounded from their pandemic lows, topping out at of that year.
The S&P 500 was trading at around 3,500 back then. And as always, there was .
Today, the index is near 6,900.
That’s right. The S&P just about doubled in five years.
And if you’re keeping track of the math, the reason why stock prices doubled as the P/E ratio was relatively unchanged is because also doubled during the period, .
To be clear, this wasn’t smooth sailing. We had a and a .
If you successfully sold the highs and bought the lows during that period, then I’m happy for you.
But most of us are in that yields a return that’s better than simply holding or during the period.
Maybe we’re due for a correction that sees stock prices falling sharply lower, which would cause P/E multiples to move closer to their historical averages.
Or maybe valuations remain stretched.
Or maybe we get an outcome where prices climb and valuations come down.
“P/E multiples can compress from prices falling but also from earnings rising,” BofA’s Savita Subramanian wrote earlier this month.
That’s right. If earnings are heading higher, as long as prices are rising at a slower rate.
The critical variable we keep falling back on is earnings, which makes sense when you remember they’re the .
And fortunately for investors, earnings are expected to grow at a double-digit rate .
