Why the Market is Still a Good Deal
The market may be near its highs, but its historic price-to-earnings ratio still make the S&P 500 look affordable.
J.P. Morgan Asset Management publishes some great research at the end of every quarter called the “Guide to the Markets.” It is chock-full of good data, but one highlight in the most recent stood out, prompted by a single question, “Is the S&P 500 over-bought?”
According to J.P. Morgan, the answer is no. Let me tell you why.
On Dec. 31st, 1996 the Standard and Poor’s 500 index was trading at 741. At that time, the S&P 500 had a 12-month forward price-to-earnings ratio of 16. This is a fancy way of saying that the index (price) was 16 times higher than the earnings that a consensus of analysts expected would be reported over the coming 12 months.
By March of 2000, the S&P 500 was trading at 1,527 and had a forward P/E of 25.6. When a P/E increases, it is because either the index (price) went up, the earnings went down, or a combination of both. In this case, the index’s rise from 741 to 1,527 caused the P/E to increase from 16 to 25.6.
Essentially, as the P/E is rising, it is telling investors they are paying more and more for one dollar of earnings.
Let’s fast forward to October 9th, 2002. The S&P 500 had careened down 49 percent to 777 and had a forward P/E of 14.1 as the tech bubble burst and a recession ensued. From there, it was a slow, steady march up back up to an index level of 1,565 by October 9th, 2007, a 101 percent gain.
At that point, the forward P/E was at 15.2 percent and we all know what happened from there.
By March 9th of 2009, the S&P 500 had lost 57 percent to bottom out at 677 and had a forward P/E of 10.3. Ouch.
However, fast forward to today, and by the end of the first quarter, things were much different! The S&P 500 had recovered to 1,569 with a forward P/E of 13.8, which is a 130 percent run.
So, it’s probably natural to assume that since the market has had a nice run, it’s time for it to take a “breather.” That is certainly a popular thought these days. In fact, nary has a day gone by where I haven’t heard that message repeated over and over on TV or in print.
But look again at the current forward P/E (at 13.8). It’s is still lower than where it was during the market low in 2002 (14.1). In fact, it’s also lower than October of 2007 (15.2), which was the last time the S&P 500 was above 1500. My opinion is that the S&P 500 is not overbought. In fact, if the forward earnings stay the same as on March 31st, 2013, the S&P 500 would have to reach a level of 1,700 before the forward P/E reached 15.2—a level last seen in October of 2007. Meaning, there is still room to grow.
David B. Armstrong, CFA, is a Managing Director and Co-founder of Monument Wealth Management, a Registered Investment Advisor located just outside Washington, DC in Alexandria, Va. David is routinely featured in national media sources and has been a speaker at several major industry conferences including Barron’s Winner’s Circle, IMCA, InsideETFs, LPL Financial Business Leaders Forums and Focus conferences. Follow David on his blog which can be found on his website, on Twitter @MonumentWealth, and on the Monument Wealth Management Facebook page.
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