While some analysts argue that the S&P 500’s higher-than-average price-to-earnings (P/E) ratio is setting up a weak 2022, an article in Fisher Investments posits that valuations are actually down over the past few years. Looking at the S&P 500, P/E has been rising since 2018—often cited as a sign that stocks are being overvalued. And while the P/E does currently exceed pre-pandemic levels, it is down overall by 10% since May 7th.
The reason for this? The E improved faster than the P over the last 6 months, the article maintains. Earnings fell last year during lockdowns, then bounced this year driven by reopening growth. As earnings grew quicker than price, the ratio dropped.
Forward P/Es are falling too, thanks to earnings as well. As earnings shatter expectations, investors bid stock prices higher, but in reality they’re paying less for expected future earnings growth than they were last year.
However, the article notes, P/Es can sometimes indicate when expectations are getting out of control, with a spike often preceding bull market peaks. But the last 14+ months have been a slow drift lower, not a spike. And analysts often focus on the P more than the E in P/Es—ignoring the fact that expensive stocks can go up in price and even cheap markets can get cheaper. In the end, P/E is a loose gauge that can’t predict where the market will go next week or next year.